Question 1

Given below is a Keynesian model of income determination (figures are in millions of dollars; interest rate (i) is in percent per annum. Assume that the price level (P) is fixed).

Goods Market

C = 300 + 0.9YD (Private consumption)

YD = Y + TR T (Disposable income)

T = 80 +0.1Y (Total taxes)

I = 400 (Private investment)

G = 200, TR = 100 (Gov. Expenditure and Transfers, respectively)

X=200 (Exports)

IM = 120 + 0.2Y (Imports)

Y = C + I + G + NX (Goods mkt. equilibrium condition)

Endogenous Variables: C, YD T, I, Y, IM

Exogenous Variables: Co, To, Io, Go, TRo, Xo, IMo

Parameters: c, t , m

Policy variables: Fiscal policy: (G, t and TR) Monetary policy: (N/A)

a) Compute the equilibrium values Y, C and T in the above model. (4 marks)

b) Calculate the expenditure multiplier in the model. (1 mark)

c) Calculate the change in Y given an increase in I by $50m and show using a well labelled Keynesian cross diagram (3 marks)

d) If Investment now includes an interest induced component, the IS relation now is

Y = [A_o bi].

Explain the role of parameters and b in the IS relation. (2 marks).