Re: simple keynsian model

Posted by anon_econ on Jul 23, 2011; 8:03am
URL: http://discussion-forum.276.s1.nabble.com/simple-keynsian-model-tp6609876p6613186.html

vishakha wrote

guys here are some problems from dornbusch chapter 3......please help me with answers.....i jus started with macro for ma entrance...



1.suppose an economy is operating at equilibrium with Y=1000.if the govt undertakes a fiscal change so that the tax rate (t) increases by 0.05 nd govt spending increases by 50,will budget surplus go up or down?why?


2.suppose govt decides to reduce transfer payment but to increase govt spending by an equal amount.....would you expect equilibrium income to rise or fall as a result of this change.why?


3.suppose aggregate demand function makes an intercept on x-axis instead of y axis and is as usual +sloped....will mpc be <1 or >1 and why?how does it fundamentally differ from a typical AD curve that makes an intercept on y-axis?

It's been a while since I studied macro, but I'll try.
1) ΔB.S= tΔY + YΔt-ΔG
YΔt-ΔG=50-50=0,
ΔY= (ΔG-cYΔt)/(1-c(1-t'))= (50-0.05cY)/(1-c(1-t'))
The numerator of this is 50(1-c), which is positive, as is the denominator.
So ΔY is positive, and therefore ΔB.S will be positive.

2) No, because a reduction in transfer payments would reduce aggregate demand only by the marginal propensity to consume times the reduced transfer payments, whereas an increase in govt spending would show up fully in the aggregate demand. Since MPC<1, the reduced transfer payements will not fully offset the impact of increased gov spending on aggregate demand, & eqm income would increase.

3) This could happen if the autonomous consumption is negative. I think the intercept per se doesn't say anything about the MPC, but in this case if the MPC is less than 1, there would be no equilibrium because the AD line would not intersect the 45 degrees line in the 1st quadrant. So to have an equilibrium MPC must exceed 1. Mathematically, Y*= (c0+I+G)/(1-c)
If the numerator (the intercept) is negative, the denominator would have to be negative if we want a positive Y*.