Posted: February 4th, 2015

Economic Problems

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Econ 320 – HW 1 ECON 320 – Intermediate Macroeconomic Theory Homework 1 1 Automatic Stabilizers Suppose that consumption is modeled as in lecture: C = c0 + c1YD where YD = Y − T is disposable income. Now suppose that instead of treating taxes (T) as exogenous, tax policy is conducted according to the following equation: T = t0 + t1Y that is, taxes depend on income. Assume that 0 < t1 < 1. Continue to treat government spending (G) and investment (I) as exogenous. 1. Solve for equilibrium output. 2. What is the multiplier? Does the economy respond more to changes in autonomous spending when t1 is 0 or when t1 is positive? Explain. 3. Why would this type of fiscal policy be called an automatic stabilizer? 2 Balanced Budget vs. Automatic Stabilizers Suppose tax policy is conducted as in the above problem. 1. Solve for taxes in equilibrium. 2. Suppose that the government starts with a balanced budget (ie. G = T) and that there is then a drop in consumer confidence (c0 drops). What happens to income and taxes? 3. Suppose that the government adjusts spending (G) to keep the budget balanced. What will the effect be on Y ? Does this effect counteract or reinforce the effects of the drop in consumer confidence? 1Econ 320 – HW 1 3 The Money Multiplier Suppose that people hold no currency, the ratio of reserves to deposits is 0.1, and that the demand for money is given by the following: Md = Y (.8 − 4i) where Y is income and i is the interest rate. Initially, the monetary base is $100 billion and nominal income is $5 trillion. 1. What is the demand for central bank money? 2. Find the equilibrium interest rate by setting the demand for central bank money equal to the supply of central bank money. 3. What is the overall supply of money? Is it equal to the overall demand for money at the interest rate you found in part b? 4. What is the impact on the interest rate if central bank money is increased to $300 billion? 5. If the overall money supply increases to $3,000 billion, what will be the impact on i?