Homework 1 - Review sheet on Simple Keynesian – via NYU Classes Assignment tab
You may handwrite if you wish but please try to make it legible
(1) Explain the following 3 ways of writing the condition for equilibrium income
(i) Y = E;
(ii) I = S;
(iii) Ip = Ir where Ip = planned investment and Ir = realized investment.
In which component of investment is a discrepancy between the two likely to occur?
(2) Suppose that initially equilibrium income was 200 units (Y=200) and that this was also full employment the full-employment level of income. Assume that the consumption function is
C = 25 + 0.8(Y-T)
From this initial equilibrium level, assume investment decline by 8 units.
i. What will be the new equilibrium level of income?
ii. What increase in government spending would be required to restore income to the initial level of 200 units?
iii. Alternately, what reduction in tax collections would be sufficient to restore an income level of 200?
(3) Explain carefully why the tax multiplier [dy/dT = -b/(1-b)] is negative and why it is smaller in absolute value than the government expenditure multiplier [dy/dG = 1/(1-b)]
(4) Given:
C = a + b(Y – T);
I = I
G = G
Supposed that instead of a fixed level of taxes (lump-sum taxes), taxes depend on income as follows (tax is endogenous):
T = tY where 0
Derive an expression for the multiplier and compare to the case where taxes are exogenous i.e. the multiplier = 1/(1-b). What happens to the size of the multiplier with taxes endogenous? Why?