Consider a closed economy where consumption is a linear function of disposable income, YD, according to the following equation

C = c0+c1YD. Investment is fixed at an initial level I = I. Government purchases of goods and services are denoted by G and

total taxes minus transfers are denoted by T .

Give an expression for total saving as a function of total income Y and the other variables of the economy.

(Hint: total saving is the sum of private and public saving)

Use the IS equilibrium condition to find

(a) a solution for aggregate output Y , (b) a solution for consumption C,

(c) and a solution for saving S.

Due to the current recession, the government is considering increasing government spending G, or decreasing net taxes T . Use your previous answers to determine the impact on output, consumption and saving of

(a) increasing government spending in G.

(b) decreasing net taxes in T.

Assume that I = $3,000, G = $3,500, T = $1,550, c0 = $2,800, c1 = 0.5.

(a) Determine the value of aggregate output.

(b) To help boost the economy the government decided to send stimulus checks. These are transfers sent directly to private households. The total cost of the program is $500. Use your previous answers to estimate the level of output after the program is implemented.

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