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.]