# government spending multiplier

Consider a closed economy, with fixed prices, represented by the following set of equations:

D = C + I + G

C = cYd

Yd = (1 - t)Y

t = 0.25, c = 0.8

I = 700 - 100r

G = 300

L = 2500 + 2Y - 500r

Where, D is the aggregate demand, C is consumption, Yd is the disposable income, t is the tax rate, I is investment, r is the interest rate (measured as a %), G is government spending and L is money demand.

(a) Let the government pursue an interest rate target of 7%. How does it achieve this target? Hence determine the equilibrium level of income Y, the government surplus tY-G and the private sector surplus (1-c) Yd - I. Comment on why D = Y in equilibrium.

(b) Using the same data, calculate the effects of increasing G to 400.

(c) Now let the government pursue a policy of holding the money supply constant at 500, and spending G = 300. What will be the level of income and the rate of interest?

(d) Using the above data, and continue to pursue a fixed money supply target of 500, recalculate your result when government spending increases to G = 400. Comment on the effects, of monetary factors, on the government spending multiplier.

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#### Solution Preview

Consider a closed economy, with fixed prices, represented by the following set of equations:

D = C + I + G

C = cYd

Yd = (1 - t)Y

t = 0.25, c = 0.8

I = 700 - 100r

G = 300

L = 2500 + 2Y - 500r

Where, D is the aggregate demand, C is consumption, Yd is the disposable income, t is the tax rate, I is investment, r is the interest rate (measured as a %), G is government spending and L is money demand.

(a) Let the government pursue an interest rate target of 7%. How does it achieve this target? Hence determine the equilibrium level of income Y, the government surplus tY-G and the private sector surplus (1-c) Yd - I. Comment on why D = Y in equilibrium.

When r = 7%,

I = 700 - ...

#### Solution Summary

The government spending multiplier is found.

If the government spending multiplier is 6, what is the tax multiplier?

Please see the attached file.

1. If the government spending multiplier is 6, what is the tax multiplier?

2. You are given this account for a bank:

ASSETS LIABILITIES

RESERVES $ 500 $ 3,500 DEPOSITS

LOANS 3,000

The required reserve ratio is 10 percent.

A. How much is the bank required to hold as reserves, given its deposits of $ 3,500?

B. How much are its excess reserves ?

C. How much can the bank increase its loans ?

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