2. Goods Market with Government

Suppose you are given a standard setup with government spending. Recall our GDP identity, we will also treat government spending as exogenous Y = Cd + Id + G For national savings recall this is: Sd = Y Cd G For the following economy has full employment output of 2000 from the labor market. Goverment purchases G are 800. Desired Consumption and desired investment are given by the following functions

Cd = 1200 2000r + 0.20Y

Id = 1200 4000r

Where Y is output and r is the real interest rate (in decimal form)

(a) Find an equation relating national savings Sd, to r and Y .

(b) Using both versions of the goods market equilibrium condition, Y = Cd + Id + G and Sd = Id. Find the real interest rate that clears the goods market. Assume that output equals full employment output. (YOU MUST SHOW YOUR WORK FOR CREDIT)

(c) Suppose that Government purchases fall to 600. How does this decrease change the equation describing desired national savings?

(d) Graph the impact in the goods market of the decrease to government savings. Clearly label the old and new equilibrium quantities. What happens to the equilibrium interest rate, quantity of investment