EBK ECONOMICS OF MONEY, BANKING AND FIN
EBK ECONOMICS OF MONEY, BANKING AND FIN
5th Edition
ISBN: 8220106799727
Author: Mishkin
Publisher: PEARSON
Question
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Chapter 23, Problem 1DAP
To determine

a.The level of change in real GDP over the four most recent quarters of data available and the four quarters prior to that.

b. The level of change in real government spending and real taxes over the four most recent quarters of data available and the four quarters prior to that.

c. Provide the explanation to answer part a and part b using the IS and AD curves

Expert Solution & Answer
Check Mark

Explanation of Solution

a. Real GDP: Real Gross Domestic Product

Real Government Expenditure: Real Government Spending

PCE: Personal Consumption Expenditure

  Real Taxes  Taxes  × 100                         PCE 

[of a quarter of current year w.r.t to the prior quarter of previous year]

b.

  Level of Change in Real Govt. Spend  Real Govt Spend2 -Real Govt Spend1_                                                                                  Real Govt Spend1

[of a quarter of current year w.r.t to the prior quarter of previous year]

  Real Taxes  Taxes_ × 100                         PCE 

  Level of Change in Level of Change in Real Taxes  Real Taxes2 -Real Taxes1_                                                                                                   Real Taxes1

[of a quarter of current year w.r.t to the prior quarter of previous year]

    Year

    Quarter

    Month

    Real Govt. SpendingChange In Levels of Govt. Spend.Level of Change in Real Govt Spend %Real GDPChange in Levels of GDPLevel of Change in Real GDP %Federal Govt. Current Taxes ReceiptsPCEReal Taxes =Taxes/PCE * 100Level of Change in Real TaxesLevel of Change in Real Taxes %
    2016 Q1 Jan2903.116571.52060109.91874.43
    2016 Q2 apr2896.316663.52096.2110.51897.01
    2016 Q3 July2899.916778.12131.51111920.27
    2016 Q4 oct2901.116851.42112.9111.51894.98
    2017 Q1 jan2896.6-6.5-0.2216903.2331.72.002133.3112.11903.0328.601.53
    2017 Q2 apr2895.2-1.1-0.0417031367.52.212150.6112.21916.7619.741.04
    2017 Q3 july2899.900.0017163.8385.72.302176.7112.61933.1312.860.67
    2017 Q4 oct2921.520.40.7017286.44352.58No data113.4No dataNo dataNo data

*St. Louis Reserve Fred Database

Interpretation: Findings -

  • Real Government Spending is increasing
  • Real GDP is increasing
  • Real Taxes are reducing

b. Graphs:

Fig1: Effect of Changes in Government Spending & Taxes On Shifts on Aggregate Demand Curve

    EBK ECONOMICS OF MONEY, BANKING AND FIN, Chapter 23, Problem 1DAP , additional homework tip  1

Short Run Upward moving Aggregate Supply Curve cuts downward moving Aggregate Demand Curve at point E known as Equilibrium. Here, Gross domestic product (GDP), or (Y), is placed on the horizontal axis, increasing as it stretches to the right. The inflation rate in other words price levels makes up the vertical axis. The SARS [Short Run Aggregate Supply] curve is upward sloping, reflecting the positive relationship that exists between the price level and the number of goods supplied in the short-run. The Long Run Aggregate Supply Curve is a vertical line, reflecting the fact that long-run aggregate supply is not affected by changes in the price level. Due to increase in government spending, the aggregate demand shifts rightward from AD to AD1. When the aggregate demand curve shifts right, the quantity of output demanded a given price level rises from Y to Y1. In effect, the price levels also increase from P to P1. Thus, If the Government increases its spending, that would increase the investments and thereby increases the GDP. Similarly, A reduction in taxes will leave more disposable income and cause consumption and savings to increase, also shifting the aggregate demand curve to the right.

Fig2: Effect of Changes in Government Spending & Taxes On Shifts in IS Curve [Investment Saving Curve]

    EBK ECONOMICS OF MONEY, BANKING AND FIN, Chapter 23, Problem 1DAP , additional homework tip  2

Short run equilibrium is attained between interest rates and output when IS intersects LM curves at point E. Here, Gross domestic product (GDP), or (Y), is placed on the horizontal axis, increasing as it stretches to the right. The nominal interest rate, or (i or R), makes up the vertical axis. If there is an increase in real government spending then the IS curve would shift to the right. ie. when the government spending goes up [when G goes up] it would shift the IS curve to the right and a new equilibrium is achieved at point E1. In the same way, reduction in taxes also causes the IS curve to shift rightward leading to new equilibrium rate of interest and real GDP. This causes an increase in the rate of interest and real GDP as found in the above table.

Economics Concept Introduction

Introduction:

AD [Aggregate Demand] curve represents the relationship between the inflation rate & aggregate output when the goods market is in equilibrium. The aggregate supply curve depicts the quantity of real GDP that is supplied by the economy at different price levels. The SRAS [Short Run Aggregate Supply] curve is therefore upward sloping, reflecting the positive relationship that exists between the price level and the number of goods supplied in the short-run. The LRAS [Long Run Aggregate Supply] curve is a vertical line, reflecting the fact that long-run aggregate supply is not affected by changes in the price level.

The IS-LM model, which stands for "investment-savings, liquidity-money," is a Keynesian macroeconomic model that shows how the market for economic goods (IS) interacts with the loanable funds market (LM) or money market. It is represented as a graph in which the IS and LM curve intersect to show the short-run equilibrium between interest rates and output. The investment/saving (IS) curve is a variation of the income-expenditure model incorporating market interest rates (demand), while the liquidity preference/money supply equilibrium (LM) curve represents the amount of money available for investing (supply).

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