A & N CETERIS TUTORIAL

ECONOMIC MODEL

A model is a theoretical construct that explains a real world situation of an economy.

Economic model referred to simplified theories that shows key relations among economic
variables. An economic model is a simplification of complex economic phenomenon using
functions and graphs. Economists create in order to simplify their data so that non-economist
can understand them.

Types of variables

1) Endogenous or dependent or response variable; is a variable whose value is

determined within a specific model. It is also refers to the variable the model tries to
explain. It is the what which can be calculated inside the model. Examples are: Price,
Quantity (demanded and supplied), national income, interest rate etc.
2) Exogenous or independent or exclamatory variable; is a variable whose value is
determined outside of the model. It is a variable that the model takes as given.
Examples are: Investment, Government spending, Taxes, Exports, Imports, Income
etc.
3) Parameters: These are variables that determine the position and slope of the model.
They are using variables that are determined by econometrics techniques. They tell
the relationship between the economic variables at play.

Types of economic models

i) Demand and supply model

ii) National income model
iii) IS and LM model

DEMAND AND SUPPLY MODEL

This model explains changes in the quantity demand and supplied of a product or commodity
in relation to changes in the price of the product assuming all else equal.

EXERCISES

1. Given the three structural equations in a demand and supply model as

Qd = a – bP+cY;
Qs = g +hP;
Qd = Qs =Q

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i. Identify the endogenous and exogenous variables

ii. Solve for P* and Q*
iii. What are the values of P* and Q* if a = 80, b = 2, c = 0.2, Y = 200, h = 4, g =
10? Represent the result graphically?
iv. Suppose income increases to 2000, what will be the change in P* and Q*? v.
Represent the new values of P* and Q* graphically.
2. Consider the simple linear model given by these three structural equations:
Qd = a – bP+cY
Qs = g +hP
Qd = Qs = Q
a) Give an economic interpretation of –b, and c in the demand function
b) Derived the reduced form equations of P* and Q*
c) What will be the value of P* and Q* if a = 100, b=4, c = 0.2, g = 10, h= 6 and
Y=200?
d) Suppose income increases to 350, what will be the change in P* and Q*and the
new values for P* and Q*?
3. Kamedo limited has the following structural demand and supply model.
Qd = 80 – 2P + 0.4Y
Qs = 10 + 0.25P
Qd = Qs = Q
i. From the above structural equations derive the reduce form of P* and Q*
ii. Assuming Y = 150, calculate the value of P and Q
iii. Assuming Y increases to 200, calculate the Δ in Q* and P* and the new values
of P* and Q*
iv. Given the economic interpretation of 80, 0.25, 0.4 and 2
4. Given the structural equations of Medyan limited.
Qd = 45 -3P +0.6Y
Qs = 52 + 2P
i. Identify the exogenous and endogenous variables
ii. Derive the reduced form equation for Q and P
iii. Assuming Y = 200, calculate the value P* and Q*
iv. If Y = 20(log525 + log100), calculate the values of P* and Q*
v. Calculate the change in Q* and P* if Y changes by 25%
vi. Based on the situation in v above calculate the new values of P* and Q*

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vii. Do a graphical representation from the entire case.

5. Given the structural equations of Sarkcess limited.
Qd = 30 -0.3P +0.4Y
Qs = 26 + 0.3P
i. Identify the exogenous and endogenous variables
ii. Derive the reduced form equation for Q and P
iii. Assuming Y = 200, calculate the value P* and Q*
iv. If Y = 20(log525 + log100), calculate the values of P* and Q*
v. Calculate the change in Q* and P* if Y changes by 25%
vi. Based on the situation in v above calculate the new values of P* and Q*
vii. Do a graphical representation from the entire case.
6. Assume Qd = 165 – 7.5P + 0.001Y and Qs = -16 + 2P
a) Derived the reduced form equations for P* and Q*
b) Find the values of P* and Q* if Y = 1,000
c) Suppose Y increase by 200, what is the value of Q* and P* and the change in P*
and Q*?
7. The market demand and supply equations in a market are given as: Qd = 25 – 10P +
0.00Y; Qs = 10 + 2P
a) Derived the reduced form equations for P* and Q*
b) Assume Y = , find the value of P* and Q* and represent them graphically
c) Assuming Y decreases by 20%, what is the change in P* and Q*?
8. Assume Qd = 500 - 100P + 50Y and Qs = 1,350 + 450P
a) Interpret the values 100, 50, and 450
b) Derived the reduced form equations of Q* and P*
c) Find the value of P* and Q* if Y = 53
d) Suppose Y increases to 200. Find the new value of Q* and P*
e) Find the change in Q* and P*
9. Assume Qd = 200 - 50P + 0.1Y and Qs = -40 + 30P
a) Derived the reduced form equations of Q* and P*
b) If Y = 100, find the values of Q* and P*
c) Suppose Y increases by 40%. What are the new values of Q* and P*?
d) What are the change in Q* and P*?
10. Assume Qd = 150 - 2P + 0.001Y and Qs = 60 +4P
a) Derive the reduced form equations of Q* and P*

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144
b) If Y = 2x where X = √ , what are the values of Q* and P*?
4

c) What will be the change in Q* and P* if Y increases to 60

11. Given the demand and supply model as; Qd = 85 – 3p + 6y Qs = 12 + 4p Qd = Qs
a) Identify the dependent and independent variables in the model.
b) Derived the reduced form equations of P* and Q*
c) Calculate the values of P* and Q* if Y= 120
d) Represent the values of P* and Q* graphically
e) If Y increases by 60, calculate the new values of P* and Q*
f) Represent the new values of P* and Q* graphically.
12. Given the demand and supply model as; Qd = 90 – 0.6p – 0.3y Qs = 8 + 4p Qd = Qs
a) Identify the exogenous and endogenous variables in the model
b) Give an economic interpretation of 0.6, 0.3, and 4 in the model.
c) Derived the reduced form equations for P* and Q*
d) If Y = 15(Log28 + Log381), calculate the values of P* and Q*
e) Calculate the change in Y, P* and Q* if Y increases to Y=45(Log525 + Log77 ) and
hence the new values of P* and Q*.
13. Given the demand and supply model as; Qd = 55 – 0.1p – 0.3y Qs = 5 + 3p Qd = Qs
a) Derive the reduced form equations of P* and Q*
b) If Y = 10(Log381 + Log10100), find the values of P* and Q*.
c) Calculate the new values of P* and Q* if Y increases by 10.
d) Calculate the change in P* and Q*
14. Given that Qd = 30 – 0.3P + 0.2Y Qs = 8 + P
a) Derive the reduced form equations for P* and Q*
b) Assume Y = 1200. What will P* and Q* be?
c) Suppose Y increases to 2,000, what will be the new values of P* and Q*? What is
the change in P* and Q*
d) Give an economic interpretation of 0.2
15. Given the following models. Qd = 80 – 0.4P + 0.7Y Qs = 5 + 3P
a) Derive the reduced form equations for P* and Q*
b) Assume Y = 10(log525 – log33). What will P* and Q* be?
c) Suppose Y increases by 40, what will be the new values of P* and Q*? What is the
change in P* and Q*

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NATIONAL INCOME MODEL

The national income of a country is the total monetary value of all goods and services in the
economy within a given period of time.

Multiplier this refers to change in the aggregate demand resulting from change in
consumption, government expenditure and investment.

EXERCISES

CLOSED ECONOMY

1) Given the structural equations in a national income model as

Y = C+I+G

C = a + bYd

Yd = Y – T

T = T0

G = G0

a) Identify the endogenous and exogenous variables in the model

b) What is the meaning of (a) and (b) in the consumption function?

c) Determine the reduced form equations for Y* and C*

d) Given that a = 100, b = 0.75, I = 150, T0 = 60, G0 = 350, find the values of Y* and

C*

2) Given the structural equations in a national income model as

Y = C+I+G

C = a + bYd

Yd = Y – T

T = tY

G = G0

i. Identify the endogenous and exogenous variables in the model

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ii. What is the meaning of (a) and (b) in the consumption function and (t) in the tax function

iii. Determine the reduced form equations for Y* and C*

iv. Given that a = 100, b = 0.75, t = 0.2, I = 150, T0 = 60, G0 = 350, find the values of Y*
and C*

3) Given the structural equations in a national income model as

Y = C+I+G

C = 70 + 0.5Yd

Yd = Y – T

T = 0.2Y

G = 100

a) What is the meaning of 0.5 and 0.2 in the consumption and tax function?

b) Derive the reduced form equations for Y* and C*

c) Assume that Government spending on education and health increases by 20 percent, what
is the new values of Y* and C*

d) Calculate the change in Y* and C* when Government spending on health increases by 20

percent? Find also the values of Y* and C*

4) Given the structural equations in a national income model as

Y = C+I+G

C = 120 + 0.75Yd

Yd = Y – T

T = 0.25Y

G = 200I = 250

a) What is the meaning of 0.75 and 0.25 in the consumption and tax functions?

b) Derive the reduced form equations for Y* and C*

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c) Assume that Government spending is twice Investment, what is the new values of Y* and
C* and the change in Y* and C*?

5) Given the national income model:

C=100+0.3Yd

T=0.12Y

Yd=Y-T

Y= C+I+G

(a) Find the reduced formed equations for Y and C

(b) Assume that I=35 and G is twice I. find the value of the reduced formed equations of Y
and C. [Where I=Investment, G= Government spending]

(c) Assume that investment increased by 20%, find the change in Y and C and the level of the
reduced equation of Y and C.

(d) Give an economic interpretation of 0.3 and 0.12

6) Consider the following structural equation of a simple national income model

Yd = Y – T

T = 0.2Y

C = 95 + 0.3Yd

Y=C+I+G

a) Identify the endogenous and exogenous variables

b) Interpret 0.2 and 0.3 in the structural equation above
c) Derive the reduce form equation of Y* ad C*
d) You are required to calculate the value of the C* and Y* given that I = 35 and G = 40
e) If G increase by 20 what is the value of C* and Y*

7) Given a simple national income model of Kamedo limited analyze the given economic
situation.

C = 45 + 0.12Yd

T = 0.02Y

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Y=C+I+G

i. Identify 0.12 and 0.02 from the structural equation above

ii. Identify the endogenous and exogenous variables
iii. Derived the reduced form equation of Y* and C*
iv. Calculate the value of Y* and C* if Io is 30 and Go is 55
v. Assume Io increases to 45. What is the change in C* and Y* and also the new values
of C* and Y*

8) Mayakie republic has the following structural equations;

C = 110 + 0.25Yd

T = 0.2Y

Y=C+I+G

i. Interpret 0.25 and 0.2 from the structural equation above

ii. Identify the endogenous and exogenous variables

iii. Derived the reduced form equation of Y* and C*

iv. Calculate the value of Y* and C* if Io is 70 and Go is 85

vi. Assume Io increases by 20% and IO increases by 15. What is the change in C* and Y*
and also the new values of C* and Y*

9) A closed economy with government activities, given Y = C + I + G, C = a + bYd; G = Go,

I = Io ; Yd = Y – T; T = tY; a = 0.2; t = 20%; b = 0.6; Io = 70 and Go = 65.

a) Calculate the level of national income

b) Calculate the government spending balance (multiplier)

10) Consider a closed economy with the variables defined as follows; a = 65; Io = 75; Go = 0;
MPS = 0.4; t = 30%;. Calculate the national income and multiplier

11) given the simple national income model; C = 40 + 0.13Yd; T = 0.2Y; Yd = Y – T; Y = C

+I+G

a) Identify the endogenous and exogenous variables

b) Derived the reduced form equation for Y* and C*

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√81
c) Assume government spending (G) = 200 and investment (I) = 40x, where x = *
√4
4 1/2
) . Calculate the level of income and consumption
9

d) When government spending increases by 15%. What will be the new values of Y*
and C*

12) Given an economy with government investment where the following variables where
determined from the survey; a = 7, I = 90; G = 65; X = 80; M = 40; b = 0.9; m = 0.15; t =
20%. Where Y = C + I +G + X – M; C a + bYd; M = M + mY

a) Find the aggregate demand

b) Government multiplier
c) Suppose the autonomous x is increase from 80 to 100 and autonomous investment
decreases from 90 to 40, determined the new level of output.

IS (Investment Spending) AND LM (Liquidity Money) MODEL

The IS curve shows the combination of the interest rate and output for which the goods
market is at equilibrium. It is the also known as the goods market. It is characterized by Y =
C+I+G

The LM curve refers to the combination of interest rate and output for which the money
market is in equilibrium. It is also called the money market. It is characterized by Ms = Md.
Where Ms = money supply and Md = money demand.

EXERCISES

1. The following information of a closed economy is given as follow; C = 100 + 0.8Y,

I = 200 – 30r; Md1 = 0.25Y; Md2 = 137.5 – 25r; Ms = 2500
a. Find the IS and LM curves
b. Find the equilibrium income
c. Determine the interest rate
d. Determine the level of investment
e. Determine the consumption level

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2. The following equations describe an economy. Y = C + I + G; C = 120 + 0.15(Y – T);

𝑀
I = 100 – 10r; G = 50; T = 40; ( 𝑃 )𝑑 = Y -20r; M = 600; P = 20

i. Identify each variables and briefly explains the meanings

ii. From the above list use the relevant set of equations to describe the IS curve.
Graph the IS curve on an appropriate labelled graph
iii. From the above list use the relevant set of equations to describe the LM curve.
Graph the LM curve on an appropriate labelled graph.
iv. What are the equilibrium level of income and equilibrium of interest rate
3. Given the IS/LM model; C = C(Yd) = 200 + 0.1(1-0.4)Y; I = i(r) = 20 – 0.15r; L =
L(Y,r) = Y – 0.7r. Where C is consumption, I is investment, r is interest rate, L is
money demand and Y is the output.
a) Give the economic interpretation of 0.4, 0.15 and 0.7
b) Derived the reduced form of equation for Y* and r*
c) Assume government expenditure = 300 and Ms = 800. Calculate the level of
income
d) What is the new value of income Y when government spending = 330 and Ms =
880
4. Given the following information about a closed economy. C = 100 + 0.8Y, I = 120 –
30r; the precautionary and transitionary demand for money is defined as Md1 =
0.25Y; speculative demand for money is given by Md2 = 1375 – 25r. Nominal money
supply is defined as Ms = 2500
A. State the IS/LM equations, hence determine the equilibrium values of income and
interest rate
B. Assume that the budget is ow introduced into the system and the consumption is
given by C = 100 + 0.75Yd, the tax function is specified as T = 20 + 0.2Y, and the
government spending is 935, find the new equilibrium values of income and
interest rate.
C. Show how a decrease of 43.74 I the autonomous part of the speculative demand
for money will affect both income and the rate of interest

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