Question 1:

a.     Given: C = 200 + 0.8Yd, I = 100, G = 100, T = 50

The aggregate expenditure function in a closed economy is:
AE = C + I + G
AE = 200 + 0.8Yd + 100 + 100
AE = 200 + 0.8(Y - 50) + 100 + 100
AE = 400 + 0.8Y - 40
AE = 360 + 0.8Y

b.     Given: C = 200 + 0.8Yd, I = 100, G = 100, T = 50

Yd = Y - T
Since AE = Y, we can solve for Y:

From the expenditure approach of GDP:

               Y = C + I + G
               Y = 200 + 0.8Yd + 100 + 100
               Y = 200 + 0.8(Y - 50) + 100 + 100
Y = 200 + 0.8(Y - 50) + 100 + 100
Y = 400 + 0.8Y - 40
Y - 0.8Y = 360
0.2Y = 360
0.2Y/0.2 = 360/0.2
Y = 1800
 
c.     Investment increases from 100 to 110. Hence, change in I is 10.
 
Y = 200 + 0.8(Y - 50) + 110 + 100
Y = 410 + 0.8Y - 40
Y - 0.8Y = 370
0.2Y = 370
0.2Y/0.2 = 360/0.2
Y = 1850

d.    Output Level is 3,000. Baseline Y  = 1800.

 
Change in Y = 3,000 - 1800 = 1200
Marginal Propensity to Consume (MPC) is 0.8.
[1/(1-MPC)] is the government spending multiplier.
 
We can use the small increments approach to solve for the change in government expenditure.
 
Change in Y = [1/(1-MPC)] * Change in government expenditure
1200  = [1/(1-0.8)] * Change in government expenditure
1200  = 5 * Change in government expenditure
1200/5  = (5 * Change in government expenditure) /5
240  = Change in government expenditure

Therefore, the government should focus on increasing its expenditure by 240 dollars to create full
employment.

 
 
e.     Output Level is 3,000. Baseline Y  = 1800.
 
Change in Y = 3,000 - 1800 = 1200
Marginal Propensity to Consume (MPC) is 0.8.
 
We can use the small increments approach to solve for the change in taxes. The effect of taxes
on output level is negative. The tax multiplier is [- MPC/(1-MPC)]
 
Change in Y =  [- MPC/(1-MPC)] * Change in taxes
1200  = [- 0.8/(1-0.8)] * Change in taxes
1200  = - 4 * Change in taxes
1200/-4  =(- 4 * Change in taxes) / -4
              -300  = Change in taxes

Thus, the government should aim at reducing taxes by 300 dollars to establish the full employment
output.

 
Question 2:

a) Equilibrium exists where Y = Aggregate expenditure= $80 billion

b) MPC = change in consumption/change in real GDP

= 140-40/200-0 = 100/200 = 0.5

It can be calculated by taking any two points on the planned aggregate expenditure curve . I have
taken the starting and ending point.
c) AE = C+I+G
C: consumption
I: investment
G: government expenditure

d) C = autonomous consumption + MPC*Y

= 40 + 0.5Y
S = -autonomous consumption + (1-MPC)*Y
= -40 +0.5Y

Question 3:

Part A

1- There is inflationary gap as actual GDP Y1 is greater than potential GDP YP

2- Contractionary fiscal policy which will reduce GDP.

3- The government can increase taxes and/or reduce government expenditure. This will reduce
aggregate demand to AD2.

4- New equilibrium is at E where price is P2 and GDP YP

Part B

Crowding out is the reduction in private investments as a result of increase in interest rates in the
economy (cost of borrowing from commercial banks). This increase is usually brought about by
expansionary fiscal government policies involving increased government spending. Reduced
investment leads to reduced production levels which in turn affects supply of goods and services
through reduced supply. This raises commodity prices in the market.

Part C

1)Government budget in Mexico is 220 Million dollars. The budget is lower than the tax revenues
which are at 232 Million dollars. This indicates a budget surplus of 12 million dollars

2)Government budget in Colombia is 180 Million dollars. This budget is lower than the tax revenue
at 171 Million dollars. The government is facing a budget deficit of 9 million dollars