1.a) explain how the level of saving is determined in the simple Keynesian consumption function?

Saving is that part of income which is not spent on current consumption. The relationship between
saving and income is called saving function and saving function (or propensity to save) relates the
level of saving to the level of income. The consumption function, or Keynesian consumption
function, is an economic formula that represents the functional relationship between total
consumption and gross national income. the aggregate consumption function
states that real consumption is a function of real income and then the
consumption function can be written as C = C(Y) where C is real
consumption expenditure and Y is real national income. This is the
Keynesian Consumption Function. Keynes stated that the rate of interest
may have some influence on consumption but the real income was the
important determinant of consumption.

The Saving Function under Keynesian consumption function:

The saving function can be deduced from the consumption function. Saving
is defined as the difference between income and consumption. The saving
function can be known from the consumption function.

The saving function has the following characteristics:

(1) Saving is directly related to income.

(2) Average Propensity to Save (APS) increases as income increases.

This means that MPS is greater than APS. If consumption is a linear

function of income, the saving function will also be a linear function of
income. If the consumption has a positive intercept with the vertical axis
the saving function will have a negative intercept with the vertical axis.

The saving function has four characteristics as the consumption function

has four characteristics which are given as follows:

(1) Saving is a stable function of income,

(2) The marginal propensity to save lies between zero and one,

(3) The average propensity to save is directly related to income,

(4) The marginal propensity to save remains constant or increases as

income increases. The consumption function and the saving function are
both linear or non-linear. However, if the consumption function is concave
from below, the saving function is convex from below.

If the consumption function is proportional the saving function is also

proportional. If consumption is proportional to income, the consumption
function will be a straight line passing through the origin. So will be the
saving function. Thus, in the long-run, the consumption function and the
saving function will be straight lines through the origin.

the effect of an increase in disposable income on the level of saving?

Disposable income: For most people, the single most powerful determinant
of how much they consume is how much income they have in their take-
home pay. This left-over income is also also known as disposable income,
which is income after taxes.

Disposable income, also known as disposable personal income (DPI), is the amount
of money that households have available for spending and saving after income
taxes have been accounted for.
DPI=Personal Income−Personal Income Taxes
For example, consider a family with a household income of $100,000, and the family
has an effective income tax rate of 25% (versus marginal tax rate). This household's
disposable income would then be $75,000 ($100,000 – $25,000). Economists use
DPI as a starting point to gauge households' rates of savings and spending.
When disposable income increases, households have more money to either save or
spend, which naturally leads to a growth in consumption. Consumer spending is one
of the most important determinants of demand; it creates the demand that keeps
companies profitable and hiring new workers.
If disposable income decreases, households have less money to spend and save,
which then forces consumers to consume less and become more frugal. This
decrease in consumption could then decrease corporate sales and corporate
earnings, decreasing the value of individual stocks. This decrease in individual share
price valuations could then lead to a market-wide decrease in value. This potentially
leads to depression or recession.
b. explain Keynes's theory of how expectations effect investment demand. How is this theory related
to Keynes's view that aggregate demand would be unstable in the absence of government
stabilization policies? (300-350 words)

how expectations effect investment demand under Keynes's theory:

Expected future income: Consumer expectations about future income also
are important in determining consumption. If consumers feel optimistic
about the future, they are more likely to spend and increase overall
aggregate demand. News of recession and troubles in the economy will
make them pull back on consumption.
Investment can change in response to its expected profitability, which in
turn is shaped by expectations about future economic growth, the creation
of new technologies, the price of key inputs, and tax incentives for
investment. Investment can also change when interest rates rise or fall.

Keynes believed that business investment is the most variable of all the
components of aggregate demand. Keynes’s treatment of investment
focuses on the key role of expectations about the future in influencing
business decisions.
When a business decides to make an investment in physical assets—like plants or
equipment—or in intangible assets—like skills or a research and development
project—that firm considers both the expected benefits of the investment, like
future profits, and the costs of the investment, such as interest rates.

The clearest driver of the benefits of an investment is expectations for future

profits. When an economy is expected to grow, businesses perceive a growing
market for their products. Their higher degree of business confidence will
encourage new investment. For example, in the second half of the 1990s, US
investment levels surged from 18% of GDP in 1994 to 21% in 2000. However,
when a recession started in 2001, US investment levels quickly sank back to 18%
of GDP by 2002.

Aggregate demand would be unstable in the absence of government stabilization policies:

Aggregate demand is the sum of four components: consumption, investment,
government spending, and net exports. Keynesian economics argues that Aggregate Demand
deficiency can be compensated with government spending on public works (expansionary fiscal
policy.) o In Keynes’s words: “socialize investment.”
The third component of aggregate demand is spending by federal, state, and local
governments. Although the United States is usually thought of as a market
economy, government still plays a significant role in the economy. Government
provides important public services such as national defense, transportation
infrastructure, and education.

Keynes recognized that the government budget offered a powerful tool for
influencing aggregate demand. Not only could aggregate demand be stimulated by
more government spending—or reduced by less government spending—but
consumption and investment spending could be influenced by lowering or raising
tax rates.

Keynes concluded that during extreme times like deep recessions, only the
government had the power and resources to move aggregate demand.

c. Suppose that government spending was increased by 20 units and that this increase was financed
by a 20-unit increase in taxes. Would equilibrium income change or remain the same as a result of
these two policy actions? If equilibrium income changed, in which direction would it move, and by
how much? Explain.

Note: please make a diagram on a blank page then insert it on the word page properly.(500 words)

In an economy with international trade, we must account for the desired expenditures of
foreigners on domestic goods (and for the desired imports of foreign goods by domestic
buyers). Both domestic and foreign buyers of tradable goods face a choice between goods
produced in the home country (America, for convenience) and goods produced abroad

A numerical example should clarify the definition of the real exchange rate. The relative
price of foreign goods (in terms of American goods) is the amount of American goods you
must give up in order to get one unit of foreign goods. To buy one foreign good you need P*
units of foreign currency, where P* is the foreign price level. The nominal exchange rate e
measures the price of foreign currency (in terms of dollars), so each unit of foreign currency
costs e dollars. Thus, you need eP* dollars in order to buy one unit of foreign goods. Since
each American good costs P dollars, you need to give up 1/P American goods to obtain a
dollar. Therefore, to get eP* dollars you have to give up eP*/P units of American goods; the
real and nominal exchange rates are linked by the formula ε = eP*/P.
The higher is the real exchange rate, the more expensive foreign goods are relative to
domestic ones, so the more inclined both foreign and domestic buyers are to buy domestic
goods. Thus, desired expenditures on domestic goods should depend positively on ε, as
shown by Romer’s modified expenditure function.

c. Suppose that government spending was increased by 20 units and that this increase was financed
by a 20-unit increase in taxes. Would equilibrium income change or remain the same as a result of
these two policy actions? If equilibrium income changed, in which direction would it move, and by
how much? Explain.

Note: please make a diagram on a blank page then insert it on the word page properly.(500 words)

The equilibrium level of the national income is defined as that point where the
aggregate supply and the aggregate demand are equal to each other.

1.a) explain how the level of saving is determined in the simple Keynesian consumption function?

What is the effect of an increase in disposable income on the level of saving? (400-500 word)

b. explain Keynes's theory of how expectations effect investment demand. How is this theory related
to Keynes's view that aggregate demand would be unstable in the absence of government
stabilization policies? (300-350 words)

c. Suppose that government spending was increased by 20 units and that this increase was financed
by a 20-unit increase in taxes. Would equilibrium income change or remain the same as a result of
these two policy actions? If equilibrium income changed, in which direction would it move, and by
how much? Explain.

Note: please make a diagram on a blank page then insert it on the word page properly.(500 words)

Q. no. 2.

1. Consider the impact of an increase in thriftiness in the Keynesian cross suppose the consumption
function is

C=C+c(Y-T)

where C is a parameter called outonomous consumption and c is the marginal propensity to

consume.

a. What happens to equilibrium income when the society becomes more thrifty, as represented by a
decline in C?

b. What happens to equilibrium saving?

c. Why do you suppose this result is called the paradox of thrift?

d. Does this paradox arise in the classical model? why or why not ? (4 marks)

ii. use the keynesian cross to predict the impact on equilibrium GDP of

a. An increase in government purchases. (50 words)

b. An increase in taxes. (50 words)

c. Equal-sized increases in both fovernment purchases and taxes (50 words)

iii. the fed is considering two alternative monetary policies:

* holding the money supply constant and letting the interest rate adjust, or

* adjusting the money supply to hold the interest rate constant.

in the IS-LM model, which policy will better stabilize output under the following conditions?

a. All shocks to the economy arise from exogenous changes in the demand for goods and services.

b. All shocks to the economy arise from exogenous changes in the demand for money. (3 marks)

Q. no. 3. Within the IS-LM model, show how income and the interest tate are affected by each of the
following: (Each part answer contain 70-100 words)

a. A decline in government spending.

b. An autonomous increase in investment spending.

c. A decline in the money supply.

In each case, explain why the changes in income and the interest rate occur.

3,ii. Explain the relationship between the effectiveness of monetary policy and the interest elasticity
of investment. Will the monetary policy be more or less effective the higher the interest elasticity of
inbestment demand? Now explain the relationship between the effectiveness of fiscal policy and the
interest elasticity of investment demand. Why do the two relationships ditter ? (200 words) (2
marks)

Q-no,4. Suppose we were in a situatio where the interest elasticity of investment is law, and money
demand is very interest elastic. Explain the effect on the income of monetary and fiscal policy action.

Ahich of the two policies is more effective? (250 words) (2 marks)

4,ii.the mundell-Fleming model takes the world interest rate r as an exogenous variable . Let's
consider what happens when this variable changes. ( Each part answer contain 70-100 words) (3
marks )

a. What might cause the world interest rate to rise?

b. In the Mundell-Fleming model with a floating exchange rate, what happens to aggregate income,
the exchange rate, and the trade balance when the world interest rate rises ?

c. In the Mundell-Fleming model with a fixed exchange rate, what happens to aggregate oncome,
the exchange rate, and the trade balance when the world interest rate rises?

Q.5. Maxroeconomic data do not show a strong correlation between investment and interest rates.

Let's examine why this might be so. Use our model in which the interest rate adjusts to equilibrate
the supply of loanable funds ( which is upward sloping) and the demand for loanable funds (which is
downward sloping). (3 marks)

a. Suppose the demand for loanable funds was stable but the supply fluctuated from year to year,
what might cause these fluctuations in supplu? in this case, what correlation between investment
and interest rates would you find?

b. Suppose the supply of loanable funds was stable but the demand fluctuated from year to year .
what might cause these fluctuations in demand? In this case, what correlation between investment
and interest tates would you find now?

c. Suppose that both supply and demand in this market fluctuated over time. If you were to
construct a scatterplot of investment and the interest rate, what would you find?

d. Which of the above three cases seems most empirically realistic to you?