1. (30 Points) Imagine an economy where general price level is constant, there is no government, and the economy does not trade with foreign economies. Further, assume the following desired consumption and investment functions: C = 500 + 0.9Y , I = 100

(a) (6 Points) Derive the aggregate expenditure function for the economy. What are the autonomous expenditure and marginal propensity to spend? (b) (4 Points) Find the equilibrium level of national output/income in this equilibrium, and denote it by Y0.

(c) (4 Points) Assume that in an economy like this, national income is suddenly lowered by $1000. Denote this level of national income by Y1. What is the desired aggregate expenditure at this level of income? Call it AE1.

(d) (6 Points) Draw the AE function against Y . Show E0, Y0, Y1, and AE1 on your diagram.

(e) (6 Points) Do firms increase or decrease output when national income is equal to Y1? By how much? Denote the new level of output by Y2. [Hint: do not go beyond the first step of output change.]

(f) (4 Points) Is the economy in equilibrium when national income is equal to Y2? Explain why or why not.

2. (20 Points) Imagine an economy where general price level is constant, there is no government, and the economy does not trade with foreign economies. Further, assume the following desired consumption and investment functions: C = 300 + 0.9Y , I = 100 4i where, C and I are desired consumption and investment expenditure, respectively and Y shows the national income/output. C, I and Y are all measured in dollars. Finally, i shows the interest rate in percentages. 1

(a) (4 Points) Assume that interest rate is equal to 10% (i = 10). Compute the equilibrium national income under this assumption.

(b) (4 Points) Now, assume that the interest rate is decreased to 5% (i = 5) and remains at this level forever. What will be the new equilibrium national income?

(c) (3 Points) Based on your answers in parts (a) and (b), compute the simple multiplier for this economy. [Hint: use the definition of the multiplier and your answers in previous parts, not a memorized equation.]

(d) (6 Points) Assume that every step of change in output/income takes a year. What will the level of national income be 3 years after the interest rate changes?

(e) (3 Points) If you mistakenly thought that the sequence of changes in national income stops after 3 years, what would you estimate the simple multiplier to be? [Hint: use the definition of the multiplier and changes in national income after 3 years.]

3. (30 Points) Assume a simple macro model where general price level is constant and the expenditure functions are as follows: C = 45 + 0.8YD , I = 90 , G = 75 , T = 0.25Y , X = 40 , IM = 0.1Y where, C is desired consumption, YD is disposable income, I is desired investment, G is desired government expenditure, T is net taxes, X is desired exports, IM is desired imports, and Y is national income.

(a) (6 Points) Does the government have a budget deficit or budget surplus in equilibrium? [Hint: solve for the equilibrium national income and compare G and T at that level of income.]

(b) (4 Points) Plot government budget against national income in a diagram. Put national income on the horizontal axis and government budget (T G) on the vertical axis. Show the national income and government budget in the equilibrium you found in part (a).

(c) (4 Points) Assume that the government wants to make its budget balanced. So it changes the government expenditure by the amount of budget surplus (deficit) that you found in part (a). Find the national income after this change. [Hint: if budget deficit is X dollars, government lowers G by X dollars. If budget surplus is Y dollars, government increases G by Y dollars.]

(d) (8 Points) Is the budget surplus (deficit) eliminated in the new equilibrium? What didn't the government take into account?

(e) (8 Points) Since you are a brilliant economist, government hires you and asks you to find the level of G that would make the budget balance (T = G). 2 What is this value of G? [Hint: replace G with the equation for tax revenue in the AE function and solve for Y. The tax revenue in this equilibrium is what G should be to have a balanced budget.]

4. (20 Points) Imagine that the federal government of Canada increases its expenditures by $100 Billion to fight the recession caused by COVID-19. Real GDP, previously equal to $1.8 Trillion, increases to $2 Trillion and remains constant. Assume that no other exogenous change has taken place during this period and that the Canadian economy operates based on the macro model we have studied.

(a) (5 Points) Based on the information given to you, what is the marginal propensity to spend (z) in Canada? Explain and show your work.

(b) (5 Points) Assume that the Canadian imports increase from $80 Billion to $100 Billion during the time that GDP is rising and that the tax rate is equal to 0.25 in Canada. Find the marginal propensity to consume out of disposable income for Canadian households. Explain and show your work. (c) (10 Points) Assume that you can't see the way consumption expenditure and disposable income have changed during this period, as data for them is reported with a delay. Based on your knowledge of the macroeconomic model, predict by how much these variables must have changed during this period. Explain and show your work.