Section 13

The (returned) king, Aragorn the King Elessar, is a Keynesian advocate, as is his chief Steward, Faramir, younger son of Denethor.

a

Then Frodo came forward and took the crown from Faramir and bore it to Gandalf; and Aragorn knelt, and Gandalf set the White Crown upon his head, and said:

'Now come the days of the King, and may they be blessed while the thrones of the Valar endure!'

a) Draw the total expenditures and total production model for the Gondor economy. Show the equilibrium level of real GDP being produced. What are the slopes of the TE and TP curves? Put all the labels!

b) Draw the Gondor economy in a recessionary gap, using the Keynesian total expenditures and total production model. What can you say about unemployment and real GDP?

c) Draw the Gondor economy in an inflationary gap, using the Keynesian total expenditures and total production model. What can you say about unemployment and real GDP?

The King has set the income tax rate at 20% for Gondorian citizens.

Faramir has provided the following information to King Elessar:

Personal Income Consumption

$1375 $1,000

$1625 $1120

$1875 $1240

$2125 $1360

$2375 $1480

d) What are the marginal propensity to consume (MPC) and the marginal propensity to save (MPS) in Gondor?

e) What is the Gondorian economy's expenditure multiplier? What is the tax multiplier?

We are truth-speakers, we men of Gondor. We boast seldom, and then perform, or die in the attempt. Not if I found it on the highway would I take it, I said. Even if I were such a man as to desire this thing, and even though I knew not clearly what this thing was when I spoke, still I should take those words as a vow, and be held by them.

f) The economy of Gondor is in an inflationary gap of $1,000. What type of fiscal policy can King Elessar undertake to bring the economy to back to the natural unemployment rate? By what 2 methods? Graph one method using the total expenditures and total production model and explain how the policy would work. Be numerically precise, using the information in d) and e). Include unemployment.

g) The economy of Gondor is in a recessionary gap of $500. What type of fiscal policy can King Elessar undertake to bring the economy to back to the natural unemployment rate? By what 2 methods? Faramir suggests a different type and method of fiscal policy from f) to King Elessar. Graph this second method using the total expenditures and total production model and explain how the policy would work. Be numerically precise, using the information in d) and e). Include unemployment.

h) Draw and explain the effect of a change in the price level, using the TE/TP model and the AD/AS model in combination.