1. Assume a Keynesian model in which prices and interest rates are fixed and: autonomous consumption = 100; marginal propensity to consume = 0.8; planned investment (I) = 300; government purchases (G) = 600; exports (X) = 150; marginal propensity to import = 0.14; and the tax rate = 0.2 (i.e., 20 percent of income).

The unemployment rate is currently at 5%. Suppose every one percent increase in the equilibrium income causes the unemployment rate to decrease by 0.25 percentage point.

Equilibrium Y = 1 * (a + I + G + X).

1-b+ bt+m

(a) Suppose the objective is to reduce the unemployment rate to 4.5% by increasing government purchases. By how much should government purchases be increased?

(b) By what percentage will the budget deficit increase as a result of the increase in government purchases?

(c) By what percentage will the trade deficit increase as a result of the increase in government purchases?

(d) In what ways does this model exaggerate the increase in the trade deficit?

(e) General Motors has estimated that for every one percentage increase in disposable income, its sales revenue increase by 1.5 percent. General Motors' sales revenue before the expansionary fiscal policy was $150 billion. What would be GM's increase in sales revenue as a result of the increase in government purchases?