The Chinese University of Hong Kong

ECON2021D Basic Macroeconomics

2nd term, 2020-21

Assignment One
Submission deadline: 5:00pm, 8th February 2021
[To make sure that you submit by the deadline, you are advised to submit one hour
before the time above]

General instructions:
1. You should submit your assignment via Blackboard and strictly comply with the
requirements as can be found in Assignment item posted on Course Content,
Blackboard.
2. All the questions below are of similar format and difficulty to the final exams of my classes.
My goal is to provide you some exercises that help you cope with the final exam instead of
testing your ability in this occasion. Hence, the marking standard is deliberately SOFT. You
will be either given a grade of “PASS” or “FAILURE”. So, submission is all-important for
getting the marks from assignments. Non-submission always implies “FAILURE”. You
should not worry too much about whether you can submit correct answers for grading,
provided that you have really spent time on thinking about the solutions and practise.
3. Don’t waste time on plagiarizing. You will get a “PASS”, provided that you have shown
sufficient efforts exerted, regardless of whether your answer is 50% or 100% correct. But
you will surely learn nothing if you haven’t tried doing the questions yourself. On the other
hand, you should feel free to discuss your answers with your classmates. We emphasize more
on the process of thinking about, instead of the results of, assignments.
4. We will discuss assignment answers in tutorials after the submission deadlines. Nevertheless,
our policy is NOT to post any answers on the web. We will NOT release any softcopy or
hardcopy of answers. The only way for you to get the answer is to attend tutorials for the
verbal explanations given by tutors.

1. Suppose the government decides to increase government expenditure and reduce tax.
Use a simple Keynesian diagram (Keynesian cross) to illustrate the impact on
national output. You should also clearly indicate what components of national
output will be affected by this policy.

2. Consider a closed economy (no international trade) under a simple Keynesian model.
Assume investment is a constant. Tax is a lump-sum that does not depend on income.
If a government increases its expenditure by $1 but at the same time increases the
lump-sum tax by $1. Will real output be increased or decreased, and by how much?

3. Consider a short-run goods market model

Y = C + I + G + X − IM
X − IM = 0
C = c0 + 0.6(Y − T)
I = I(i)
Due to a constitutional restriction, the government expenditure and taxation policy
must satisfy the conditions below:
(i) Government expenditure must be 20% of its real output (G = 0.2Y)
(ii) The government must keep its budget balanced (G = T)
(a) Solve the equilibrium national output Y. You must state clearly the equilibrium
 condition. [Note that the values of c0, I(i), T and G are not known in this
question. Hence, your answer of Y is essentially a formula that contains some
or all these unknowns.]
(b) If investment increases by $1, and interest rate remains unchanged, Y will
increase by how much?
(c) Suppose the above constitutional rule is abandoned. Tax and government
expenditure are constants. Solve the equilibrium real output Y. If investment
increases by $1, and interest rate remains unchanged, Y will increase by how
much?

4. Assume there is no international trade (X = IM = 0) but there are private

investments, government expenditure and taxation.
(a) Use the goods market equilibrium condition to demonstrate that in
equilibrium “saving equals investment”. Clearly explain what is “saving” and its
components.
(b) The behavioural functions of this economy are given below
Consumption: C = 10+0.6(Y-T)
Investment: I = 2+0.2Y
Government: expenditure: G = 2
Taxation: T = 4
Solve the total saving function. Put total saving ST on the left and anything else
on the right side. The function should show how income affects total saving.
(c) Draw the ST=I diagram to show the equilibrium. Clearly indicate the numerical
values for all the intercepts and the equilibrium output in the diagram.
(d) Based on the model above, which items will affect autonomous saving? If
autonomous saving increases, will saving in equilibrium be higher or lower?
Illustrate this situation in the ST=I diagram.