Econ 2123 Problem set 1

Part I

1.) False. Since the equation of consumption ( C = c0 +c1YD ) Even when disposable income
equals to 0 , C0 , which is the consumption for any given level of disposable income will always be
positive, for instance the consumption for basic survival , thus consumption will not be 0.

2.) False. The multiplier ( 1/(1-c1) is greater than 1 because c1, which is the marginal propensity to
consume is always smaller than 1 because consumption increases less than one for one with
disposable income. Thus, (1-c1)is less than 1, so multiplier is larger than 1 . Not because when T =
0 and G = 0.

3.) False. It is because an increase in saving leads to a decrease in aggregate demand and thus
decline in production thus a decrease in gross output which will in turn further reduce the total
saving in short run.

4.) False. Increase in MPC = increase in c1 . Goods market equilibrium: Y =1/(1−c1) * [c0 + I − c1T
+ G], increase in c1 will enhance the multiplier effect more , a decrease in investment would leads
to a larger decrease in output by decrease in investment times 1/(1−c1) , the multiplier.

Part II
1.) A
2.) A
3.) A
4.) B

Part III
1.)
year # of HKUST Price (tuition: Nominal GDP Real GDP (in Real GDP (in
freshmen HK$) 1990 $) 2000 $)
1990 300 2,000 600,000 600,000 6,000,000

2000 900 20,000 18,000,000 1,800,000 18,000,000

2001 1000 21,000 21,000,000 2,000,000 20,000,000

2002 1100 23,000 25,300,000 2,200,000 22,000,000

2.) Growth rate of real GDP(in 2000$) for 2001 is : (20,000,000 - 18,000,000 / 18,000,000) * 100%
= 11.11%( nearest tenth)
Growth rate of real GDP(in 2000$) for 2002 is : (22,000,000 - 20,000,000 / 20,000,000) * 100%
= 10%

3.) Growth rate of real GDP(in 1990$) for 2001 is : ( 2,000,000 - 1,800,000 / 1,800,000) *100%
= 11.11%( nearest tenth)
Growth rate of real GDP(in 2000$) for 2002 is : (2,200,000 - 2,000,000 / 2,000,000) * 100% =
10%

4.) GDP deflator = (nominal GDP/real GDP) *100

Year GDP deflator

2000 (18,000,000/18,000,000*100) = 100

 2001 (21,000,000/20,000,000*100) = 105

2002 (25,300,000/22,000,000*100) = 115

Inflation rate for 2001 : [(105 - 100) / 100] *100% = 5%
Inflation rate for 2002 : [(115 - 105) / 105] *100% = 9.52%( nearest tenth)

5.) Nominal GDP growth rate = NGDPt - NGDPt-1 / NGDPt-1

Real GDP growth rate = RGDPt - RGDPt-1 / RGDPt-1
Since increase of nominal GDP growth rate could due to increase in output of goods & services
and no change in price level or an increase in both output of goods & services and price level or an
increase in price level & no change in output of goods & services. Yet, increase in real GDP growth
rate can only be due to an increase in output quantity of goods & services. Thus, the rate of
inflation for HKUST in the year of 2010 = 10% - 4% = 6%

Part IV
1.) c0 = 160, c1 = 0.6

(1) Y = 1/1- c1 [ c0 + I + G - c1T ]

Equilibrium GDP(Y) = 2.5*400 = $1000

(2) Disposable income (YD) = Y - T = 1000 - 100 = $900

(3) Consumption spending (C) = 160 + 0.6 YD = 160 + 0.6*900 = $700

(4) Since marginal propensity to consume(MPC) = c1 , MPC = 0.6

(5) Marginal propensity to save (MPS) = 1 - c1 = 0.4

(6) Multiplier = 1/(1-c1) = 1/(1-0.6) = 2.5

Autonomous spending = (c0 + I + G - c1T) = $400

(7) Private saving = Y - T - C = 1000 - 100 - 700 = $200

Public saving = T - G = 100-150 = $-50

2.)
(1) Equilibrium output :
Y=C+I+G
Y = c0 + c1Y − c1T + I + G
(1 − c1)Y = c0 + I − c1T + G
Y =1/(1−c1) * [c0 + I − c1T + G]

Total demand : Z = (c0 + I + G - c1 T) + c1 Y

Z = 160 + 150 + 150 - (0.6*100) + (0.6*1000)
Z = 1000
Y = 1000
Total demand (Z )= $1000 is equal to production (Y) =$1000


(2) Equilibrium output :

Y=C+I+G
Y = c0 + c1Y − c1T + I + G
(1 − c1)Y = c0 + I − c1T + G
Y =1/(1−c1) * [c0 + I − c1T + G]

Total demand : Z = (c0 + I + G - c1 T) + c1 Y

Z = 160 + 150 + 110 - (0.6*100) + (0.6*1000)
Z = 960
Y = 1000 

Total demand ( Z ) = $1000 is not equal to production (Y)=$1000

(3) Equilibrium output = $960

G = $110
Investment = $150
sum of private and public saving = ( Y - T - C) + (T - G) = (1000-100-700) + ( 100-110) = $190
sum of private and public saving(190) is not equal to investment (150) because the
economy is not at equilibrium now with G = 110 , the production ( Y=1000) is not equal
to ( Z = 960) . thus, the sum of private and public saving is not equal to investment when
it is not at equilibrium.

3.)
(1) Equilibrium output :
Y=C+I+G
Y = c0 + c1(Y − T) + I + G
Y = c0 + c1(Y − t0 − t1Y ) + I + G
Y =1/(1−c1+c1t1)*[c0 − c1t0 + I + G]
Equilibrium tax :
T=t0 +t1 Y
T=t0 +t1 {1/(1−c1+c1t1)*[c0 − c1t0 + I + G] }

(2) Multiplier = 1/(1−c1+c1t1) is the sum of all the successive increases in production with initial 1
increase in demand. It means any change in autonomous spending will change output by more
than one for one. The economy response more tho autonomous spending when t1 is 0 .It is
because with increase in t1, the multiplier decrease , thus the blow-up effect becomes smaller,
which means more decrease in output.

(3) Since multiplier in this case = 1/(1−c1+c1t1) < 1/(1-c1) = standard multiplier of goods market.
With taxes have a stabilizing effect since they automatically move with economic growth, the
output would response less with 1 increase in autonomous spending , more stable output , thus
fiscal policy is an automatic stabilizer in this case.

(4) Balance budget : (G=T) , with a drop in c0, Y would decrease by c0 times
1(1−c1+c1t1). With decrease in Y , tax ( T=t0 +t1 Y) would also decrease.

(5)Government cuts spending means decrease in G , it will leads to a decrease in Y by the

decrease in G times 1(1−c1+c1t1). Y would decrease even more alongside with drop in c0,
thus cut in spending doesn’t counteract with the drop in c0.


(6)A balance budget requirement actually destabilising because a balance budget needs
(G=T), with decrease in c0, it leads to decrease in Y and decrease in T. Since G must
equals to T, G would also decrease. With G decrease , Y would decrease even more with
multiplier effect of G and c0.

4.)
(1) Equilibrium output :
Y=C+I+G
 Y = c0 + c1(Y − T) + I + G
Y = c0 + c1(Y − T) +b0 +b1 Y + G
Y = [1/(1 − c1 − b1)] ∗ [c0 − c1T + b0 + G]

(2) Multiplier = [1/(1 − c1 − b1)]. Increase in investment would increase the value of b1
which would increase the value of multiplier . For multiplier to be positive , (1 − c1 − b1) >
0 , [1-( c1 + b1)] > 0 , so it means ( c1 + b1) must be negative , ( c1 + b1)< 0

(3)b0 increase would leads to an increase in Y with multiplier effect. Y = [1/(1 − c1 − b1)] ∗
[c0 − c1T + b0 + G], increase in b0 multiplied by [1/(1 − c1 − b1)]. I = b0 +b1 Y , investment
would change more , investment would change with increase in b0 plus b1 multiplied by the
change in output. The increase in b0 will leads to a surge in production , which would leads to
further increase in investment. Since national saving and investment has a IS relationship
[ S + (T – G) = I ], increase in investment means increase in national saving. Thus, increase in Y
would increase in national saving.