Question

M.4

1. Suppose the United States economy is represented by the following equations: Z=C+I+G YD=Y-T I = 30 C = 100 + 5YD G= 100 T = 200 a) Which variables are endogenous and which are exogenous? b) Calculate equilibrium levels of output, consumption and disposable income c) What is the multiplier for this economy d) What is the effect of increasing G by $100 on Y and the deficit

Answer 1

Ans.
a) Endogenous variables are those which can be determined within the model because of the relation with other model variables.. So, consumption which changes with changes in income (Y) is an endogenous variable.

Exogenous variables are variables which are determined outside this model and have no relation with other variables within te model. Thus, T, I and G are exogenous variables.

b) This Z represents the aggregate expenditure,

Z = C + I + G

=> Z = 100 + 0.5(Y - 200) + 30 + 100

=> Z = 130 + 0.5Y

At equilibrium, Aggregate Expenditure = Y,

=> Y = 130 + 0.5Y

=> Y = 260

=> Yd = Y - T = 260 - 200 = 60

=> C = 100 + 0.5*60 = 130

c) In the consumption function, C = 100 + 0.5Yd,

Marginal Propensity to Consume (MPC) = 0:5

Thus, the multiplier = 1/(1-MPC) = 1/(1-0.5) = 2

d) Increase in Y = multiplier * Increase in G

=> Increase in Y = 2*100 = 200

The budget deficit is G - T,

Budget deficit before increase in G = 100 - 200 = -100, which means that there is a budget surplus.

Budget deficit after increase in G by 100 = 200 - 200 = 0, which means the government is running a balanced budget.

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