Problem Set 7 ID s The Effects of Government Borrowing
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1 staple tagets Staple Me o lose 1 point. Intoduction to Macoeconomics IDs oblem Set 7 ID s The Effects of Govenment Boowing Closed Economy, No Foeign Secto, Savings Responds to the Inteest Rate Oveview: In this poblem set, you will investigate how changes in govenment spending, financed by changing the govenment s suplus o deficit, affect an economy in the long-un. In paticula, you will investigate thee scenaios diffeing only by the amount of govenment spending (and boowing) in an economy. You will detemine the equilibium conditions, at the natual ate of output ( Nat ), o this economy. Refeences: We will investigate this in class. Chapte 13 of you text also coves much of this. Assumptions: It is assumed that the time peiod is long enough fo the economy to always etun to natual ate of output ( Nat ), but is not long enough fo that natual ate of output to gow. Thee is no foeign secto in this model. It is an economy that is closed to foeign tade and capital flows. Savings esponds to the inteest ate. Finally, govenment boowing o savings is assumed to have nothing to do with the inteest ates. i,e, You SGov and DGov columns should be the same numbe all the way down fo a given situation. Don t foget that a suplus means the govenment is supplying money to the loanable funds maket (i.e. the suplus goes in the SGov column). Example: On page 2 you ae given a completed example showing the equilibium conditions an economy. U.S. supply and demand fo loanable funds is composed of pivate U.S. demand fo loanable funds (i.e. Investment), the pivate U.S. supply of loanable funds (i.e. net savings by households), and govenment boowing (a demand fo loanable funds) o govenment savings (i.e. the govenment is a supplie of loanable funds if it uns a. utting it all togethe, we find that the loanable funds maket will be in equilibium at a eal inteest ate of 7.5%. At that inteest ate, U.S. pivate quantity supplied, i.e. Savings, is $1,300. Investment, i.e. the pivate demand fo loanable funds, is $800. The key is on page 3. You Tun: Now comes the fun pat. On pages 6 8, you ae given 3 diffeent situations. The situations only diffe by the amount of govenment spending and the esulting govenment budget balance. Fill in the chats and detemine the esults fo each situation. Fill out the summay on page 4. Gaph the C, showing all thee situations, on page 5. Staple and tun in pages 4 8. Due Date: Beginning of Class on Fiday, 26 Apil. 1
2 Staple Me o lose 1 point. Intoduction to Macoeconomics IDs Div Spiv = + SGov DGov = STotal DTotal 8.5% $1,500 $ % 8.5% 8.0% $1,400 $ % 8.0% 7.5% $1,300 $ % 7.5% 7.0% $1,200 $ % 7.0% 6.5% $1,100 $1, % 6.5% 5.0% $1,000 $1, % 5.0% 4.5% $ 900 $1, % 4.5% 4.0% $ 800 $1, % 4.0% 3.5% $ 700 $1, % 3.5% Example You ae given the U.S. pivate loanable funds maket and the following infomation: Govt Spending (excl. tansfes) = $1,750 Taxes (net of tansfes) = $1,250 Real GD = $4,500 Resouce Mkt You should get the following esults: 1) the U.S. Govt. table, 2) the (total) loanable funds maket) and 3) the items below: Govt. Deficit o Suplus = E = I = S = C = 2
3 Staple Me o lose 1 point. Intoduction to Macoeconomics IDs Div Spiv = + SGov DGov = STotal DTotal 8.5% $1,500 $ % $0 $ % $1,500 $1, % $1,400 $ % $0 $ % $1,400 $1, % $1,300 $ % $0 $ % $1,300 $1, % $1,200 $ % $0 $ % $1,200 $1, % $1,100 $1, % $0 $ % $1,100 $1, % $1,000 $1, % $0 $ % $1,000 $1, % $ 900 $1, % $0 $ % $ 900 $1, % $ 800 $1, % $0 $ % $ 800 $2, % $ 700 $1, % $0 $ % $ 700 $2,200 $4,500 $800 $1,750 $1,950 Example You ae given the U.S. pivate loanable funds maket and the following infomation: Govt Spending (excl. tansfes) = $1,750 Taxes (net of tansfes) = $1,250 Real GD = $4,500 $4,500 $800 $500 Resouce Mkt $1,250 0 $1,3 0 $4,500 You should get the following esults: 1) the U.S. Govt. table, 2) the (total) loanable funds maket) and 3) the items below: Govt. Deficit o Suplus = $500 E = 7.5% I = $ 800 S = $1,300 C = $1,950 3
4 Staple Me o lose 1 point. Intoduction to Macoeconomics IDs Name: S # 6 uestions (in addition to filling in the chats) Situation 1 1. What is the equilibium eal inteest ate? 2. What is the $ value of: Investment? Savings? Consumption? 3. How do leakages and injections compae in this situation? a. leakages > injections b. leakages = injections c. leakages < injections 4. How does the govt deficit in situation 1 compae to situations 2 and 3? Situation 1 has the: a. highest deficit (lowest b. middle deficit o suplus c. lowest deficit (highest Situation 2 5. What is the equilibium eal inteest ate? 6. What is the $ value of: Investment? Savings? Consumption? 7. How do leakages and injections compae in this situation? a. leakages > injections b. leakages = injections c. leakages < injections 8. How does the govt deficit in situation 2 compae to situations 1 and 3? Situation 2 has the: a. highest deficit (lowest b. middle deficit o suplus c. lowest deficit (highest Situation 3 9. What is the equilibium eal inteest ate? 10. What is the $ value of: Investment? Savings? Consumption? 11 How do leakages and injections compae in this situation? a. leakages > injections b. leakages = injections c. leakages < injections 12. How does the govt deficit in situation 3 compae to situations 1 and 2? Situation 3 has the: a. highest deficit (lowest b. middle deficit/suplus c. lowest deficit (highest Geneal uestions 18. In this poblem set, the economy is at Nat. The composition of the economy changes, but not the % of capacity used. What time peiod is this assuming? a. the long-un b. the shot-un 13. Investment is a(n): a. leakage b. injection c. neithe 14. Savings? a. leakage b. injection c. neithe 15. Taxes is a(n): a. leakage b. injection c. neithe 16. Govt spending is a(n): a. leakage b. injection c. neithe 17. How do leakage and injections compae in this time peiod? a. leakages > injections b. leakages = injections c. leakages < injections d. it vaies fom situation to situation 19. In this poblem set, how does an incease in the govenment deficit affect this economy? Use Incease, No Change, o Decease in the blanks. Inteest ates Investment Consumption 18. The assumptions and esults of this poblem set best fit which school of thought? a. Keynesians b. Classicals 4
5 Econ Intoduction to Macoeconomics John Lovett Daw the economy s C and label each situation. Make sue you clealy label each axis. Use the numbes fom you thee situations. Don t change the scale on an axis. You may, howeve, inset a beak ( ) nea the base of an axis if you wish. The gaph has 50 tick maks on both the vetical and hoizontal axis if that helps. 5
6 ECON IDs Div Spiv = + SGov DGov = STotal DTotal 8.5% $1,700 $1, % 8.5% 8.0% $1,650 $1, % 8.0% 7.5% $1,600 $1, % 7.5% 7.0% $1,550 $ 1, % 7.0% 6.5% $1,500 $1, % 6.5% 6.0% $1,450 $1, % 6.0% 5.5% $1,400 $2, % 5.5% 5.0% $1,350 $2, % 5.0% 4.5% $1,300 $2, % 4.5% Situation 1 You ae given the U.S. pivate loanable funds maket and the following infomation: Govt Spending (excl. tansfes) = $2,400 Taxes (net of tansfes) = $2,000 Real GD = $8,000 You should get the following esults: 1) the U.S. Govt. table, 2) the (total) loanable funds maket) and 3) the items below: Govt. Deficit o Suplus = $ E = % I = $ S = $ C = $ Resouce Mkt 5
7 ECON IDs Div Spiv = + SGov DGov = STotal DTotal 8.5% $1,700 $1, % 8.5% 8.0% $1,650 $1, % 8.0% 7.5% $1,600 $1, % 7.5% 7.0% $1,550 $ 1, % 7.0% 6.5% $1,500 $1, % 6.5% 6.0% $1,450 $1, % 6.0% 5.5% $1,400 $2, % 5.5% 5.0% $1,350 $2, % 5.0% 4.5% $1,300 $2, % 4.5% Situation 2 You ae given the U.S. pivate loanable funds maket and the following infomation: Govt Spending (excl. tansfes) = $2,000 Taxes (net of tansfes) = $2,000 Real GD = $8,000 You should get the following esults: 1) the U.S. Govt. table, 2) the (total) loanable funds maket) and 3) the items below: Govt. Deficit o Suplus = $ E = % I = $ S = $ C = $ Resouce Mkt 7
8 ECON IDs Div Spiv = + SGov DGov = STotal DTotal 8.5% $1,700 $1, % 8.5% 8.0% $1,650 $1, % 8.0% 7.5% $1,600 $1, % 7.5% 7.0% $1,550 $ 1, % 7.0% 6.5% $1,500 $1, % 6.5% 6.0% $1,450 $1, % 6.0% 5.5% $1,400 $2, % 5.5% 5.0% $1,350 $2, % 5.0% 4.5% $1,300 $2, % 4.5% Situation 3 You ae given the U.S. pivate loanable funds maket and the following infomation: Govt Spending (excl. tansfes) = $1,600 Taxes (net of tansfes) = $2,000 Real GD = $8,000 You should get the following esults: 1) the U.S. Govt. table, 2) the (total) loanable funds maket) and 3) the items below: Govt. Deficit o Suplus = $ E = % I = $ S = $ C = $ Resouce Mkt 8
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