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Question 2 [21 points]

A simplified economy is specified as follows:

A. Goods market, all values C, I, G and NX values are in billions of C$:

Consumption Expenditure:

C = 150 + 0.8(Y-T)

Investment Expenditure:

I = 1,100 - 560i

Government Expenditure:

G = 320

Lump-sum Constant Taxes:

T = 320

Exports:

70

Imports:

10

B. Money market, all M^dvalues are in billions of C$:

Interest Rate:

i= 0.09 or 9%

Money Demand:

M^d= 840 - 2,100i

Note:Please keep your answers accurate to two decimal places.

a)Given the above information, solve for the following: the equilibrium Y, the money supply M, the consumption expenditure C, and the investment expenditure I.

Y

=

6,618

M

=

651

C

=

5,188.4

I

=

1,049.6

Now suppose there is an impending federal election, and the government promises to use fiscal policies to stimulate the economy.

b)Find the value of the goods market multiplier.

Goods market multiplier

=

5

c)Let G rise to 420. Solve for the new equilibrium Y and C.

Y

=

7,118

C

=

5,588.4

d)Demonstrate how the increase in G affects the economy through the multiplier. Use three rounds of effects to demonstrate the multiplier effects. Let the first round be related to health care spending, the second round related to clothing, and the third round related to food.

Round 1 -> As the government wants to spend $1 (or $1 billion)

on health care, it demands the production of health care equipment

such as hospitals, medicine, equipment, etc. to be built and sold to

the government. So as G = 1, the production Y =

5

. This Y is the

income to the nurses, doctors, construction workers, etc.

Round 2 -> As the nurses receive their new income of Y =

5

, they

spend

0.8

% of this $

5

on clothing ->

4

cents worth of clothing would

be produced, or Y =

0

-> this

0

cents would be the income of the

workers involved in making the clothing.

Round 3 -> As the clothing workers receive their new income of

Y =

0

, they spend

0

% of this

0

cents on food -> (

0

)(

0

) =

0

or

0

cents worth of food would be produced, or Y =

0

-> this would

be the new income to the food workers.

e)Now consider monetary policies only. Suppose the BOC wants to drop theito 0.04 or 4%, with G still at $320. Solve for the new I and the I compared to wheni= 0.09. Given the multiplier, how much would you expect Y to rise by?

I

=

0

Change in I

=

0

Change in Y

=

0

f)Given the changes in (e), find the equilibrium Y, the money supply M, the consumption expenditure C, and the investment expenditure I.

Y

=

0

M

=

0

C

=

0

I

=

0

g)Complete the following statement to demonstrate how the drop iniaffects the money supply, then I, then Y, then C.

As i decreases -> M

(Select One)

-> I

(Select One)

-> Y

(Select One)

-> C

(Select One)

Official Time: 10:13:58