True, False, or Uncertain

Explain why each of the following statements are True, False or Uncertain according to economic principles.

Use diagrams where appropriate. Unsupported answers will receive no marks.

5) When aggregate consumption is $100 Bil, while disposable income is $120 bil, the marginal propensity to save from disposable income must be 20%.

7) In an economy with a mix of price-taking and price-setting firms, the short-run aggregate supply curve will be horizontal.

8) If the government reduces tax rates, the aggregate expenditure function shifts up.

Long-answer problems:

9) Suppose the following aggregate expenditure model describes an economy:

C = consumption, Yd = disposable income, T = taxes, Y = national income, I = investment, G = govt spending, X = exports, IM = imports

C = 100 + (5/6)Yd, T = (1/5)Y, I = 200 , G = 400 , X = 300 , IM = (1/3)Y

a) Derive a numerical expression for aggregate expenditure (AE) as a function of Y. Calculate the equilibrium level of national income. Illustrate in a diagram with AE on

the vertical and Y on the horizontal axis. (do not convert fractions into decimals)

b) Calculate the equilibrium levels of disposable income, consumption spending and private saving (S). Is the government running a surplus or deficit? Does the country

have a trade surplus or deficit?

c) Now imagine that as a result of international trade tensions exports decrease by 200. What is the new level of national income? Illustrate the effects in your diagram.

What is the effect on the government's budget? (using multiplier simplifies the calculations)

d) The govt decides to use an increase in government spending to restore national income to its original level. By how much would it have to increase spending? What

happens to the govt's budge balance? Explain why the govt's deficit does not increase by the full amount of the increase in spending.

10) Suppose that the initial equilibrium in the previous question was both a short and long0run equilibrium in AD-AS space.

A) Analyze the short-run effects of the event described in part c above. Would the effect on real GDP be the same or different? Explain.

B) Show the effect of the govt's action from part d above. How is the price level affected compared to your answer in part a of this question?

C) Suppose instead that the govt did not respond as in part d above. How would the economy adjust? What would be the long-run level of real GDP?