Problem Set 4 The Effects of Government Borrowing Closed Economy, No Foreign Sector, Savings Responds to the Interest Rate

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1 Eco Intemediate Macoeconomics John Lovett oblem Set 4 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 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 full employment, fo this economy. Refeences: This mateial is coveed in chaptes 9 (especially pp ) and 12 (especially pp ) of you text and in you notes. Assumptions: It is assumed that the economy is at full employment. 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 is assumed to have nothing to do with the inteest ates. i,e, You S Gov and D Gov columns should be the same numbe all the way down fo a given situation. Example: On page two 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. 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 suplus). 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. You Tun: Now comes the fun pat. On pages 3 5, you ae given 3 diffeent situations. The situations only diffe by the amount of govenment spending. In situation 1, the govenment is unning a balanced budget. In situation 2, it is unning a deficit. In situation 3, it is unning a suplus. Fill in the numbes, simila to the example, and answe the questions on page 6. Tun in page 6.

2 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 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 $1,250 0 $1,3 0 $4,500 2 Govt. Deficit o Suplus = $500 E = 7.5% I = $ 800 S = $1,300 C = $1,950

3 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% 6.0% $1,000 $1, % 6.0% 5.5% $ 900 $1, % 5.5% 5.0% $ 800 $1, % 5.0% 4.5% $ 700 $1, % 4.5% Situation 1 maket and the following infomation: Govt Spending (excl. tansfes) = $1,750 Taxes (net of tansfes) = $1,750 Real GD = $5,500 3 Govt. Deficit o Suplus = E = I = S = C =

4 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% 6.0% $1,000 $1, % 6.0% 5.5% $ 900 $1, % 5.5% 5.0% $ 800 $1, % 5.0% 4.5% $ 700 $1, % 4.5% Situation 2 maket and the following infomation: Govt Spending (excl. tansfes) = $2,000 Taxes (net of tansfes) = $1,750 Real GD = $5,500 4 Govt. Deficit o Suplus = E = I = S = C =

5 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% 6.0% $1,000 $1, % 6.0% 5.5% $ 900 $1, % 5.5% 5.0% $ 800 $1, % 5.0% 4.5% $ 700 $1, % 4.5% Situation 3 maket and the following infomation: Govt Spending (excl. tansfes) = $1,500 Taxes (net of tansfes) = $1,750 Real GD = $5,500 5 Govt. Deficit o Suplus = E = I = S = C =

6 . Hee s My oblem Set # 4. Name: at 1: Situation 1 at 2: Situation 2 at 3: Situation 3 at 4: Geneal uestions 1. What condition is the govenment budget in?: a. deficit b. balanced c. suplus 2. What is the equilibium eal inteest ate? 3. What is the $ value of U.S. Investment? $ 4. What is Investment, a leakage o an injection? 5. What is Savings, a leakage o injection? 9. What condition is the govenment budget in?: a. deficit b. balanced c. suplus 10. What is the equilibium eal inteest ate? 11. What is the $ value of U.S. Investment? $ 12. What is Investment, a leakage o an injection? 13. What is Savings, a leakage o injection? 17. What condition is the govenment budget in?: a. deficit b. balanced c. suplus 18. What is the equilibium eal inteest ate? 19. What is the $ value of U.S. Investment? $ 20. What is Investment, a leakage o an injection? 21. What is Savings, a leakage o injection? 25. In this poblem set, we assumed that the economy is at F. i.e. We assumed that changes in govenment spending do not change the size of poduction. What time peiod ae we assuming? a. the shot-un b. the long-un c. the doo un-un-un 26. When thee was an incease in govenment spending, financed by a deficit, what if anything was cowded out? 6. What is Taxes, a leakage o injection? 7. What is Govt spending, a leakage o injection? 8. How do leakages and injection compae? 14. What is Taxes, a leakage o injection? 15.What is Govt spending, a leakage o injection? 16. How do leakages and injection compae? 22. What is Taxes, a leakage o injection? 23.What is Govt spending, a leakage o injection? 24. How do leakages and injection compae? 27. In geneal,how do leakages and injection compae? 28. Neatness Counts! 6

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