Macroeconomics Extra Credit (5 points)

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28 Οκτ 2013 (πριν από 3 χρόνια και 10 μήνες)

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Macroeconomics Extra Credit
Algebra

Due

Thursday
,
May 9


This is just for extra credit

if you are into algebra and would like to see what is done in
intermediate
macroeconomics
.
You will receive up to 5

point
s of extra credit

based on the
accuracy of your

answers
.
You should not copy someone’s work.

If you turn in a correct
problem, you should be able to work a
s
imilar problem if I ask you to.
If you turn in a copied
answer and are not able to work a similar problem in class,
bad things will happen
.
Th
is
assignment is not required

and you will not s
ee problems like it on any exam. The 5 points would
count as 1 of 2 extra credit articles.

(To remind you of the extra credit articles

write up two
paragraphs of your opinion of a news article, economic spe
ech, etc. Two paragraphs of your
opinion is probably an easier way to get extra credit than working through the algebra.)



Below is the algebra for our model of the economy. We can solve for the equilibrium level of
GDP just like we did graphically.





(1) AE

= C + I

+ G + (X


IM)

Definition of AE




(2) C =

+ MPC
Y


Consumption Function





(3) I =



Investment




(4) G =



Government Purchases




(5) X =



Exports



(6) IM =



Imports




(7) Y = AE



Equilibrium Condition


(a)

Solve for the equilibrium level of GDP.



As an example, I have solved the model below for a simplified version, where
govern
ment and international trade ha
ve

been left out.




AE = C + I



C =



+ MPC Y



I =




Y = AE



Combining the first and last equations, since AE = C + I and since Y =
AE in equilibrium, then in equilibrium:




Y = C + I



Next, substitut
e in all of the middle equations
:




Y =

+ MPC Y +




Bringing Y terms to the left, factoring, and solving for Y:




Y


MPC Y =

+





Y (1


MPC) =

+





Y =
(
+

)/(1


MPC)



Usually written as

Y = 1/(1


MPC) x
(

+
)



w
ith the multiplier written first being multiplied by al
l the bar terms.


To solve for the equilibrium level of GDP with the 7 original equations, I s
tart out by
equating the first and last equation: If AE = C + I + G + (X


IM) and Y = AE in
equilibrium, then in equilibrium Y = C + I + G + (X


IM). Next, sub
stitute in the
middle equations: Y =

+ MPC Y +
+
+ (



). Next, bring the Y term
over to the left, factor out the Y, and divide so that you

end up with just Y on the left
hand side. The equation is usually written as Y = the multiplier times the bar terms
(
+

+

+ (



)). This i
s where our formula for the multiplier came from.
After solving the equations, plug in an MPC of .75 to calculate the multiplier.


(b)

One key factor that has been left out of this algebraic model is the tax rate.
Consumption is really a function of your a
fter
-
tax income, not your total income.
Thus, a more accurate model of the economy takes into account taxes. We would
write consumption as a function of income minus taxes:


(2a) C =

+ MPC(Y


Taxes)


We would also need an equatio
n to determine the level of taxes. The main federal tax is
the income tax. The equation below says that taxes are a function of income: the tax rate
(t) times the level of income (or Y).



(2b) Taxes = t

Y


Combining these two equations gives us a new eq
uation 2:



(2) C =
+ MPC(Y


t Y)


Use this new equation 2 to re
-
solve the model for the equilibrium level of GDP.
Note that
you now have three Y terms, so be careful in factoring and combining the Y terms.
You
will also
need to b
e careful with minus signs and parentheses.
You need to end up with
Y by itself on the left. When you are done, again separate out the bar terms from the
new multiplier.
What happens to the size of the m
ultiplier? Plug in an MPC of .75 and a
tax rate o
f .2
.


(c)


Return to the original set of equations and now substitute in the following equation
for imports:



(6) IM =
+ d Y


This equation says that imports are positively related to the level of income (Y). As U.S.
income increases
we buy more stuff, including stuff from other countries

imports
increase. Solve the system for a third time for the equilibrium level of output.
Be careful
with the sign of dY as you bring this term to the left.
What happens to the multiplier
(relative
to part (a))? Use .1 to stand for “d”, the variable that measures the relationship
between changes in income and changes in imports. Again use an MPC of .75. What
happens to the size of the multipler?