Survey
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
INSTRUCTOR: Mr. Konstantinos Kanellopoulos, MSc (L.S.E.), M.B.A. COURSE: ECON-211-01-SUI13 Intermediate Macroeconomics SEMESTER: Summer Session I, 2013 Tutorial 7 – for tutor INSTRUCTIONS Students are required to study the following questions and problems indicated and to be able to solve them by themselves. Although this is not a required part of a coursework, the purpose of the tutorial is twofold: to help the student understand the methodology for solving the problems and to help him/her prepare for the courseworks and/or exams. The utilisation of this resource can be maximised depending on the time and effort each individual student devotes. Konstantinos Kanellopoulos 12th June 2013 PART 1 SELF-TEST QUESTIONS 1. Briefly explain in words the effect of an increase in the marginal propensity to save on the size of the expenditure multiplier and the level of equilibrium income. If the marginal propensity to save (s = 1 - c) rises, then the marginal propensity to consume (c) falls. Therefore one extra dollar in income earned will now affect consumption by less than before this reduction in c. But if the marginal propensity to save is larger, then the size of the expenditure multiplier will be smaller, since the expenditure multiplier is defined as 1/(1 - c) = 1/s. We should expect that when people start to save a larger portion of their income, spending on consumption goods will decrease, leading to a decline in equilibrium income. 2. Comment on the following statement: “When aggregate demand falls below the current output level, an unintended inventory accumulation occurs and the economy is no longer in an equilibrium.” When aggregate demand falls below the equilibrium output level, actual production exceeds desired spending. Therefore firms see an unwanted accumulation in their inventories, and they respond by reducing their production level. This leads to a decrease in the level of output up to the point where the new and lower level of desired spending is again equal to the level of actual output. In other words, in the expenditure sector, the adjustment from one equilibrium to the next is based on unintended inventory changes, until the economy eventually reaches a new equilibrium at another output level. PART 2 EXAM-TYPE PROBLEMS Problem 1. Assume you have the following model of the expenditure sector: Sp = C + I + G + NX C = 400 + (0.8)YD Io = 200 G = 300 + (0.1)(Y* - Y) YD = Y - TA + TR NXo = - 40 TA = (0.25)Y TRo = 50 a. What is the size of the output gap if potential output is at Y* = 3,000? b. By how much would investment (Io) have to change to reach equilibrium at Y* = 3,000, and how does this change affect the budget surplus? c. From the model above you can see that government purchases (G) are counter-cyclical, that is, G is increased as national income decreases. If you compare this specification of G with one that has a constant level of government spending (for example, Go = 300), how would the value of the expenditure multiplier differ? d. Assume the equation for net exports changes from NXo = - 40 to NX1 = - 40 - mY. How would this affect expenditure multiplier, if we assume that 0 < m < 1? a. Sp = 400 + (0.8)YD + 200 + 300 + (0.1)(3,000 - Y) - 40 = 1,160 + (0.8)(Y - (0.25)Y + 50) - (0.1)Y = 1,200 + [(0.8)(0.75) - (0.1)]Y = 1,200 + (0.5)Y Y = Sp ==> Y = 1,200 + (0.5)Y ==> (0.5)Y = 1,200 ==>Y = 2*1,200 = 2,400 2 The output gap is Y* - Y = 3,000 - 2,400 = 600. b. From Y = (mult.)(A) ==> 600 = 2(I) ==> I = 300 BuS = TA - TR - G = (0.25)(2,400) - 50 - [300 + (0.1)(600)] = 600 - 50 - 300 - 60 = 190 BuS* = (0.25)(3,000) - 50 - 300 + 0 = 750 – 350 = 400. Therefore, the budget surplus increases by BuS = 210. c. If government purchases are used as a stabilization tool, the size of the expenditure multiplier should be lower than if the level of government spending is fixed. In the model of the expenditure sector above, the slope of the [C+I+G+NX]-line is c1 = 0.5, and therefore the size of the expenditure multiplier is α = 1/(0.5) = 2. However, if government purchases are defined as Go = 300 instead, the slope of the [C+I+G+NX]-line changes to c2 = 0.6 and the size of the expenditure multiplier changes to α2 = 1/(0.4) = 2.5. d. With this change, net exports decrease as national income increases. This additional leakage implies that the size of the multiplier will decrease. In the model above, the slope of the [C+I+G+NX]-line decreases from c1 = (0.5) to c3 = (0.5) – m, and the expenditure multiplier decreases from 1/[1 - (0.5)] to 1/[1 - (0.5) + m]. Therefore, if m = 0.14, then the expenditure multiplier decreases from α = 1/(0.5) = 2 to α3 = 1/(0.64) = 1.5625. Problem 2. Assume you have the following model of the expenditure sector: Sp = C + I + G + NX C = Co + cYD YD = Y - TA + TR TA = TAo TR = TRo I = Io G = Go NX = NXo a. If a change in income by ∆Y = - 800 leads to a change in savings by ∆S = - 160, what is the size of the expenditure multiplier? b. If a change in taxes by ∆TA = - 400 leads to an change in income by ∆Y = + 1,200, how large is the marginal propensity to save? c. If a change in exports by NX = - 200 is accompanied by a change in consumption by ∆C = - 800, what is the size of the expenditure multiplier? The expenditure multiplier for such a simple model can be calculated as: = 1/(1 - c) a. (S)/(Y) = s = 1 - c = (-160)/(-800) = 02 ==> 1/(1 - c) = 1/(0.2) = 5 ==> the multiplier is = 5. b. From (Y) = [-c(TAo)] ==> (Y)/(TAo) = (-c) = (-c)/(1 - c) ==> (1,200)/(-400) = - 3 = (-c)/(1 - c) ==> -3(1 - c) = -c ==> c = 3/4 ==> mps = s = 1 - c = 1/4 = 0.25. c. Y = C + NX = - 800 + (- 200) = - 1,000 ==> c = (C)/(Y) = (- 800)/(- 1,000) = 0.8 ==> multiplier = = 1/(1 - c) = 1/(0.2) = 5 3