Economics Written Report
AF1605 Introduction to Economics TUT006
Problem Set 8 Written Report
8.1 Suppose that the economy of FarFarAway is described by the following equations:
i. Planned consumption: C = 1000+0.8(Y-T) ii. Planned investment: I = 2000-1000r iii. Planned government expenditure: G = 2000 iv. Planned net export: NX = 90
v. Income taxes: T = tY vi. Income tax rate: t=0.20 vii. Real interest rate: r = 0.05 viii. Potential output: Yf = 15000
a. What is the short-run equilibrium output for FarFarAway? Please show your calculation. b. Briefly explain how the government of FarFarAway can change from the short-run equilibrium output (i.e. your answer to (a)) to the potential output using fiscal policy. In your answer, please state only one tool that the government can use to implement this policy and explain how it can affect output.
Answer
The short run equilibrium output is the output level at which Y = AE, which AE is the sum of consumption (C), private investment ( I ), Government expenditure (G) and Net export (NX). The equation Y = 1000+0.8(Y-T) + 2000-1000r +2000 + 90 will be obtained. Given in the question, the income taxes is T = tY. This can be substituted into the consumption function.
The equation is as follow:
Y = 1000+0.8(Y-T) + (2000-1000r) +2000 + 90
Y = 5090 + 0.8(Y-tY) -1000r
Y = 5090 + 0.8(Y-tY) -1000(0.05)
Y = 5040 + 0.8(Y-0.2Y)
Y = 5040 + 0.64 Y
Y = 14000
Therefore, the short run equilibrium output is 14000.
b. We can change from the short-run equilibrium output 14000 to the potential output 15000 using expansionary fiscal policy, which aims at increasing the short-run equilibrium output.
There are two tools that the government can use. The first one is to increase the government expenditure. The second one is to decrease taxes. Refer to the question, only one tool that the government can use to implement this policy. So to increase government expenditure should be used.
The
Problem Set 8 Written Report
8.1 Suppose that the economy of FarFarAway is described by the following equations:
i. Planned consumption: C = 1000+0.8(Y-T) ii. Planned investment: I = 2000-1000r iii. Planned government expenditure: G = 2000 iv. Planned net export: NX = 90
v. Income taxes: T = tY vi. Income tax rate: t=0.20 vii. Real interest rate: r = 0.05 viii. Potential output: Yf = 15000
a. What is the short-run equilibrium output for FarFarAway? Please show your calculation. b. Briefly explain how the government of FarFarAway can change from the short-run equilibrium output (i.e. your answer to (a)) to the potential output using fiscal policy. In your answer, please state only one tool that the government can use to implement this policy and explain how it can affect output.
Answer
The short run equilibrium output is the output level at which Y = AE, which AE is the sum of consumption (C), private investment ( I ), Government expenditure (G) and Net export (NX). The equation Y = 1000+0.8(Y-T) + 2000-1000r +2000 + 90 will be obtained. Given in the question, the income taxes is T = tY. This can be substituted into the consumption function.
The equation is as follow:
Y = 1000+0.8(Y-T) + (2000-1000r) +2000 + 90
Y = 5090 + 0.8(Y-tY) -1000r
Y = 5090 + 0.8(Y-tY) -1000(0.05)
Y = 5040 + 0.8(Y-0.2Y)
Y = 5040 + 0.64 Y
Y = 14000
Therefore, the short run equilibrium output is 14000.
b. We can change from the short-run equilibrium output 14000 to the potential output 15000 using expansionary fiscal policy, which aims at increasing the short-run equilibrium output.
There are two tools that the government can use. The first one is to increase the government expenditure. The second one is to decrease taxes. Refer to the question, only one tool that the government can use to implement this policy. So to increase government expenditure should be used.
The