Consider an economy in which taxes, planned investment, government spending on goods and services, and net exports are autonomous, but consumption and planned investment change as the interest rate changes. You are given the following information concerning autonomous consumption, the marginal propensity to consume, planned investment, government purchases of goods and services, and net exports:
Ca = 1,500 - 10r c = 0.6 T = 1,800
Ip = 2,400 - 50r G = 2,000 NX = -200
(a) Compute the value of the marginal propensity to save.
(b) Compute the amount of autonomous planned spending, Ap, given that the interest rate equals 3.
(c) Compute the equilibrium level of income, given that the interest rate equals 3.
(d) Suppose that autonomous consumption changes by 4 percent for any change in household wealth and that the decline in the housing market from 2006–09 and the drop in stock market from 2007–09 reduce household wealth by $3 trillion. Compute the decline in consumption that results from the decline in household wealth.
(e) Calculate the new amount of autonomous planned spending, Ap, and the new equilibrium level of income, given that the interest rate equals 3
(f) Using your answers to parts c–e, compute the value of the multiplier.
(g) Fiscal and monetary policymakers can respond to the decline in household wealth by taking actions that restore income to its initial equilibrium level. Fiscal policymakers can increase government spending or cut taxes or do both. Monetary policymakers can reduce interest rates. Given the values of the multiplier, the tax multipliers, and the balanced-budget multiplier, compute by how much: Government spending must be increased in order to restore the initial equilibrium level of income, given no change in taxes or the interest rate.
Taxes must be cut in order to restore the initial equilibrium level of income, given no change in government spending or the interest rate. Government spending and taxes must be increased in order to restore the initial equilibrium level of income, given no change in the government budget balance or the interest rate. The interest rate must be reduced in order to restore the initial equilibrium level of income, given no change in government spending or taxes.