Reference no: EM132410719
Consider the following aggregate expenditure model of the economy:
C = 75 +0.9Yd
I = 80
G= 50
T= 0.27
X = 60
M = 5 +0.12Y
Where C is consumption, Yd is disposable income, I is investment, G is government expenditures on goods and services, T is tax net of transfers, X is exports, M is imports and Y is national income.
(A) Solve for aggregate expenditures (AE) as a function of Y and calculate the equilibrium level of national income. Illustrate your equilibrium in a diagram with AE on the vertical axis and Y on the horizontal axis. What is the value of the multiplier? Is the government running a surplus or deficit?
(B) Using the value of the multiplier that you have found, explain what happens to the value of AE and to GDP if the government increases its expenditures from 50 to 100 (this is an expansionary fiscal policy). How does this policy affect the government's budget balance?
(C) Using diagram(s) explain why the changes of AE and GDP will be less than what is predicted in part (B) when aggregate supply (AS) curve is upward sloping.
(D) Suppose that the economy was already at its potential output (Y) in part (A). Using an AD-AS diagram, predict the effects of the fiscal policy on real GDP, the unemployment rate, and the price level in the short run and in the long-run.
(E) Explain what effect this policy is likely to have on domestic real interest rates in the country. Would we expect to see an appreciation or a depreciation of the domestic currency?
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