Homework 3 Question 2. Consider an economy that is described by the following la

Question

Homework 3 Question 2. Consider an economy that is described by the following lassical model Y=C+I+G C=10 + 0.55 * (Y-T) G=T=5 K = 10, L = 30 a) In this economy compute the equilib- rium interest rate r (b) Compute the MPC of the consumption function.2 (c) Calculate the equilibrium interest rate when G = T = 5.5 Hint: This is a special case in which you car calculate C by plugging in an arbitrary value (say 1) for Y -T, then you can calculate again C by plugging in your old number plus one (so it would be 2) for Y - T. The difference between C" and C is the MPC! This works only when C(Yd is linear

Explanation / Answer

a) First find the production level Y. We have all the required values so substitute them in the production function

Y = 1.355 x (10^0.33) x (30^(1-0.33)) = 28.29

C = 10 + 0.55*(28.29 - 5) = 22.81

This gives the equilibrium equation Y = AE

Y = C + I + G

28.29 = 22.81 + 1/2r + 5

This gives r = 1.042

Hence equilibrium interest rate is 1.042

b) MPC is the slope of consumption function and it is MPC = 0.55

c) Now that G = T = 5.5, the new interest rate at equilibrium is

Y = AE

28.29 = 10 + 0.55*(28.29 - 5.5) + 1/2r + 5.5

This gives new interest rate r = 1.957

Related Questions

Navigate

• Browse (All)
• Browse H
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.