Analyze the effect of an increase in government expenditure

Assignment Help Macroeconomics

Reference no: EM13826344

Problems-

Problem 1: An open economy has the following expenditures and money demand.

C= 2000+0.8(Y-T) Md/P = Y/20i

I = 1900-30,000i i* = 0.05

G = 1000 P* = 1

T = 1000

NX = 800-0.1Y - 400e

Nominal exchange rate is fixed at 1(E=1).

(1) Derive (1) the aggregate demand (AD) curve algebraically and (2) depict it on (Y, P) plane. (3) Explain the determinants of the location of AD curve.

(2) Suppose from now on the domestic price level is fixed at 1. (1) What are the output, interest rate, consumption, investment and net export in the short run equilibrium? (2) What is the money supply? (3) Using figure(s), describe the short run equilibrium.

(3) Suppose government expenditure increases from 1,000 to 1,300. (1) What are the output, interest rate, consumption, investment and net export in the short run equilibrium? (2) What is the money supply? (3) What is the government expenditure multiplier? Compare the multiplier with the one in Keynesian cross and explain why there is a difference. (4) Using figure(s), describe the policy effect.

(4) Explain why monetary policy does not have any effect in a fixed exchange rate regime.

(5) The government expenditure stays at 1,000, but the government devalues the exchange rate from 1 to 0.25. (1) What are the output, interest rate, consumption, investment and net export in the short run equilibrium? (2) What is the money supply? (3) Using figure(s), describe the policy effect.

(6) The government expenditure stays at 1,000 and nominal exchange rate at 1. However, foreign interest rate has decreased from 0.05 to 0.04. (1) What are the output, interest rate, consumption, investment and net export in the short run equilibrium? (2) What is the money supply? (3) Using figure(s), describe the effect of the decrease in foreign interest rate.

Now suppose the aggregate supply is given as follows.

Y = 10000 + 1000 (P-Pe)

The expected price level is given as 2 initially.

(7) (1) What is the output in medium run equilibrium? (2) What is the equilibrium output and price level in the short run?

(8) The short run equilibrium is allowed to be adjusted to the medium run equilibrium through automatic (market) mechanism without any government policy intervention. (1) What are the output, price, consumption, investment and net export in the medium run equilibrium? (2)

Using figure(s) of AD-AS/IS-LM, explain the adjustment process.

(9) Now the government uses its expenditure to move the economy from the short run to medium run equilibrium. (1) How much has government expenditure to be increased to achieve the goal? (2) Using figure(s) of AD-AS/IS-LM, analyze the policy effect.

(10) Instead of fiscal policy, the government would like to use devaluation to move the economy from the short run to medium run equilibrium. (1) What should the new exchange rate be? (2) Using figure(s) of AD-AS/IS-LM, analyze the policy effect.

Problem 2: An open economy has the following expenditures and money demand.

C= 2000+0.8(Y-T) Md/P = Y/20i

I = 1900-30,000i i* = 0.05

G = 1000 P* = 1

T = 1000

NX = 800-0.1Y - 400e

Money supply is 10,000. Nominal exchange rate is flexible. To make the problem simple, assume that they always expect the future exchange rate to be the same as the current exchange rate.

(1) Derive (1) the aggregate demand (AD) curve algebraically and (2) depict it on (Y, P) plane. (3) Explain the determinants of the location of AD curve.

(2) Suppose from now on the domestic price level is fixed at 1. (1) What are the output, interest rate, consumption, investment, net export and nominal exchange rate in the short run equilibrium? (2) Using figure(s), describe the short run equilibrium.

(3) Analyze the effect of an increase in government expenditure.

(4) Suppose money supply increases from 10,000 to 11,000. What are the short run output, consumption, investment, net export and nominal exchange rate?

(5) Money supply stays at 10,000, but foreign interest rate rises from 0.05 to
0.0505. (1) What are the output, interest rate, consumption, investment, net export and nominal exchange rate in the short run equilibrium? (2) Using figure(s), describe the effect of the increase in foreign interest rate.

Now suppose the aggregate supply is given as follows.

Y = 10000+ 1000 (P - Pe)

The expected price level is given as 7 initially. Money supply is 10,000 and foreign interest rate is 0.05.

(6) (1) What is the output in medium run equilibrium? (2) What is the equilibrium output, price level and nominal exchange rate in the short run? Note the following.

P2+ 3P -10 = (P+5)(P-2)

(7) The short run equilibrium is allowed to be adjusted to the medium run equilibrium through automatic (market) mechanism without any government policy intervention. (1) What are the output, price, consumption, investment, net export and nominal exchange rate in the medium run equilibrium? (2) Using figure(s) of AD-AS/IS-LM, explain the adjustment process.

(8) Now the central bank uses monetary policy to move the economy from the short run to medium run equilibrium. (1) How much has money supply to be increased to achieve the goal? (2) Using figure(s) of AD-AS/IS-LM, analyze the policy effect.

Additional Information-

These problems from Macroeconomics and the problems deal with the expenditures of the whole economy. Various factors such as money supply, net export, governmental policy, aggregate demand, consumption, investment, output, price, etc are calculated in the answer.

Word limits- 2000

Reference no: EM13826344

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