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Calculating Demand-Side Macroeconomic Equilibrium

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DEMAND SIDE EQUILIBRIUM ACTIVITY

1. From the following data, find the marginal propensity to consume, compute the expenditure at each level of GDP, and find the equilibrium GDP:

GDP C I G X IM

5,000 3,650 1,000 1,200 700 1,100
5,500 4,000 1,000 1,200 700 1,100
6,000 4,350 1,000 1,200 700 1,100
6,500 4,700 1,000 1,200 700 1,100
7,000 5,050 1,000 1,200 700 1,100
7,500 5,400 1,000 1,200 700 1,100

2. In an economy with no government sector, investment is 1,000, net exports are 100 and the consumption function is:

Income Consumption

3,000 2,100
3,500 2,500
4,000 2,900
4,500 3,300
5,000 3,700
5,500 4,100

a) Calculate the expenditure schedule, and find the equilibrium level of GDP.
b) What are savings at this equilibrium GDP?
c) What is the marginal propensity to consume?
d) What is the multiplier?
e) People lower their savings and raise their consumption by 200 at each level of GDP. Use the multiplier to find the new equilibrium GDP.
f) Confirm your answer to e) by calculating the new expenditure schedule.
g) What is the level of savings at the new equilibrium GDP?
h) Compare and explain your answers to b) and g).

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Solution Preview

1. See the attached file. MPC = (Change in Consumption)/(Change in Income) = 350/500 = ...

Solution Summary

This solution shows how to calculate demand-side macroeconomic equilibrium given data for GDP, Consumption spending (C), Investment spending (I), Government spending (G), Exports (X), and Imports (IM). The solution also shows how to calculate the Marginal Propensity to Consume (MPC) and the spending multiplier, and how to use the multiplier to predict the change in equilibrium in response to a change in consumption spending. A spreadsheet is provided showing how every value was calculated.

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Macroeconomic Theory

1. Suppose that an earthquake destroys part of the capital stock. Predict what will happen to (1) total production, (2) the real return to capital, and (3) the real wage. For simplicity, assume that the size of the population is unaffected.

2. Assume that GDP is 5000. Consumption is Investment is where is the real interest rate. Taxes are 1000, and government expenditures are 1500.

a. Calculate the equilibrium values of and

b. Calculate the equilibrium values of private saving, government saving, and total saving.

c. Now suppose that there is a technological innovation that makes businesses want to invest more, so that the new investment function is Calculate the new equilibrium values of and

d. Calculate the new equilibrium values of private saving, government saving, and total saving.

3. Suppose that the government finances an increase in expenditures by raising taxes, so that the budget remains balanced (in other words, ). What happens to the interest rate and investment? For simplicity, assume that the MPC out of the tax cut is positive and less than one.

See attached file for full problem description.

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