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ENGR.ECONOMIC ANALYSIS

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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Question

You are given the following information regarding a hypothetical economy:
Consumption function is C= 0.3+0.8(Y-T)
Investment I=3.5- 50i
G= 3
T= 2.5
The demand for real money is M/P=2+0.2Y-50i.
The real stock of money is 3.

d.
What is the level of consumption and investment? Do consumption, investment and
government expenditures add up to the level of output?
Calculate the money demand.
f.
е.
Suppose the government spending increases by 1 unit.

Expert Solution

Introduction

The goods market equilibrium is at the point where the Y that is income is equal to the sum of consumption level, investment expenditure, and the level of government spending or expenditure in the economy.

$Y = C + I + G$

part (d)

Goods market,

$Y = C + I + G Y = 0.3 + 0.8 (Y - 2.5) + 3.5 - 50 i + 3 0.2 Y = 4.8 - 50 i$

For money market equilibrium,

$M_{D} = M_{S}$

Therefore,

$2 + 0.2 Y - 50 i = 3 50 i = 0.2 Y - 1 i = \frac{0.2 Y - 1}{50}$

Now, putting this value of the interest in the goods asset market equation because for equilibrium the goods markets must intersect the asset market,

$0.2 Y = 4.8 - 50 i 0.2 Y = 4.8 - 50 \times (\frac{0.2 Y - 1}{50}) 0.2 Y = 4.8 - 0.2 Y + 1 0.4 Y = 5.8 Y = 14.5$

$i = \frac{0.2 Y - 1}{50} i = \frac{(0.2 \times 14.5) - 1}{50} i = \frac{2.9 - 1}{50} i = 0.038$

Therefore, Y is 14.5, and the interest rate is 3.8%

Using these values consumption and investment will be,

$C = 0.3 + 0.8 (Y - 2.5) C = 0.3 + 0.8 (14.5 - 2.5) C = 9.9$

$I = 3.5 - 50 i I = 3.5 - (50 \times 0.038) I = 1.6$

Now,

$Y = C + I + G$

Left-hand side equal to 14.5 as calculated

Right-hand side,

$= 9.9 + 1.6 + 3 = 14.5$

Yes, the sum of consumption, investment, and government expenditures are adding up the same as equal to the level of income.

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