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- Suppose consumption is given by C = 1000 + 0.75 x Disposable Income while investment is given by I = 2000 – 20r. If government expenditures equal 0 (no expenditures) and the tax rate is 1/3 (the government collects 1/3 of income as tax revenue), what is the equation of the IS curve? What are the values r-intercept and the Y- intercept?
- Using the data from #1, compute the value of the multiplier.
- Using the data from #1, suppose the full employment level of output is 5000. What is the full employment equilibrium level value for r?
- Using the data from #1, what is the government’s budget balance at the full employment level of output?
- Using the data from #1, suppose that the government decides to start spending. This raises government purchases from 0 to 2000. What is the equation for the new IS curve? By how much does the curve shift? Is this the amount predicted by the multiplier calculated in #2?
- Using the data from #1 (with G = 0), suppose investment becomes more sensitive to changes in the interest rate. This changes the investment function from I = 2000 – 20r to I = 2000 – 40r. Draw the old and new investment functions. How did the curve shift? What is the equation for the new IS curve? What are the values of the new intercepts for the IS curve? Draw the old and new IS curves to demonstrate the change.
- Using the data from #1 (with G = 0 and the original investment function), suppose the desire for savings increases. This causes autonomous consumption to fall from 1000 to 500. What is the equation for the new IS curve? What are the values of the new intercepts for the IS curve? Draw the old and new IS curves to demonstrate the change.
- Using the data from #1 (with G = 0 and the original investment function), suppose the desire for savings increases. However, this time the effect is seen by the MPC falling from 0.75 to 0.6. What is the equation for the new IS curve? What are the values of the new intercepts for the IS curve? Draw the old and new IS curves to demonstrate the change.