The Spending Allocation Model

Transcription

1 MACRO CHAPTER 7 (ECONOMICS CHAPTER 19) The Spending Allocation Model PARALLEL PROBLEMS Topic: Calculating shares of GDP 1 1. Suppose initially that C = 800, I = 300, G = 200, and X = 100. a. What is GDP? b. Calculate the four shares of GDP. c. Suppose G increases to 300 and GDP increases to 1,500. What is the new government spending share? Draw a diagram to illustrate what happens to the equilibrium interest rate. d. Without doing any calculations, explain what happens to each of the three nongovernment shares of GDP after the government spending and GDP increase in (c). e. Suppose instead that G increases to 300 and GDP increases to 2,000. What is the new government spending share? Draw a diagram to illustrate what happens to the equilibrium interest rate. f. Without doing any calculations, explain what happens to each of the three nongovernment shares of GDP after the government spending and GDP increase in (e).

2 Topic: equilibrium interest rate 2 2. a. Using the diagram below, find the equilibrium interest rate when the government share is 25 percent. What is the investment share? b. Explain what happens to all of the variables if there is an increase in the demand for U.S. exports. Topic: the government share 3 3. Suppose the government increases spending on the war on drugs by one-half a percent of GDP. a. Suppose no other policy accompanies this increase in spending. Describe this policy's effect on interest rates and on consumption, investment, and net exports as a share of GDP. b. Suppose, because of a balanced budget agreement, the funds for this policy must come from funds initially earmarked for other spending programs. Describe this policy's effect on interest rates and on consumption, investment, and net exports as a share of GDP. c. Suppose the government decides to adopt a national sales tax to pay for the higher government spending. Describe this policy's effect on interest rates and on the four shares of GDP. Topic: nongov ernment share of GDP 4 4. Suppose there is an increase in the government share of GDP. a. Draw a diagram showing the effect this has on the nongovernment share of GDP. What happens to interest rates? b. Suppose you observe that, concurrent with the increase in the government share of GDP, a decline in the net export share occurs. Is this a coincidence? Explain. c. If the decline in the net export share of GDP is substantial, what might this imply about the interest rate sensitivity of net exports?

3 Topic: saving investment approach 5 5. a. Some argue that Japan s saving rate is too high. Suppose all Japanese citizens decide to save at a lower rate. Show what happens in this case in the savings and investment diagram where the S/Y curve shifts. b. Now show the same situation in the C/Y, I/Y, and X/Y diagrams. Which curve shifts? If the government share of GDP does not change, then what must happen to interest rates? Explain how this affects the four shares. c. Suppose that when the Japanese citizens began saving at a lower rate, the government reduced its level of spending, and the government share of GDP fell. Illustrate the effect on the interest rate using the saving-investment approach and the fourdiagram approach in parts (a) and (b). What happens to the four shares of GDP? Topic: impact of a change in government purchases 6 6. Suppose the government's share of GDP declines by 10 percent. Draw a diagram like Figure 22.7 and show what the I/Y and X/Y curves would look like if there is very little change in the interest rate. Does this mean that nongovernment spending is not sensitive to changes in the interest rate? Explain. Topic: Calculating shares of GDP 7 7. Suppose that, as a result of a financial crisis in Asia, there is a large decline in the demand for U.S. exports. a. What effect will this have on the interest rate, and the four shares of GDP? b. Suppose that at the same time, there is a sharp increase in the demand for U.S. dollar-denominated assets as a result of the financial crisis in Asia. Will this tend to offset or enhance the changes that you found in part (a)?

4 Topic: investment share of GDP 8 8. Suppose, the C/Y line shifts to the right because of a change in attitude about the future. At the same time, because of political pressure, the government share of GDP declines, with the result that the interest rate stays constant. a. If the investment share is the only thing that affects growth in the system, what will happen to growth? b. If the consumption share increased by 5 percent, what must have happened to the government share? c. Suppose that when the C/Y line shifted to the right and the government cut spending, the interest rate actually fell. What happened to each of the four shares in this case? Topic: equilibrium rate of interest 9 9. Suppose the following equations describe the relationship between shares of spending in GDP (Y) and the interest rate (R), measured in decimal fractions (that is, R =.05 means that the interest rate is 5 percent). C ( R 0.06) I ( R 0.06) X ( R 0.06) G 0.2 Y = a. Use algebra to determine the value of the interest rate and the share of spending in GDP. b. Do the calculation again for a government share of 15 percent rather than 20 percent.

5 Topic: impacts on the investment share Use the equations defined in the previous problem to answer the following questions: a. Suppose that the investment share function from the previous I problem changes so that it is now ( R 0.06) Is investment now more or less sensitive to changes in the interest rate? Find the new level of the interest rate and the shares of GDP. b. Suppose the consumption share function from the previous C problem changes so that it is now ( R 0.06) Name something that could have caused this change. Find the new level of the interest rate and the shares of GDP. c. Suppose that at an interest rate of 6 percent, the trade balance was 5 percent instead of 0 percent. Find the new net export share function and the new level of the interest rate and the shares of GDP. Topic: national saving rate Derive the national saving rate-interest rate relation from the equations listed in problem # 9. Show that the equilibrium interest rate can also be determined when this relationship is set equal to the sum of the investment and net export shares. What is the equilibrium level of saving?