Macroeconomics: Econ 1031

Review Question 1

1. Consider an economy described by the following equations:

C = C+I+G+NX (1)
G = 1000 (2)
T = 1000 (3)
C = 250+0.75 (Y-T) (4)
I = 1000-50r (5)
M = 500+0.1Y (6)
X = 750

a. Write the aggregate demand equation by incorporating the values of the

variables given in equations (2) to (6) in Equation 1.
b. Write the saving equation
c. Calculate government multiplier
d. Suppose government increases its spending from 1000 to 1250, what
would be its effect on planned expenditure, equilibrium level of income,
changes in consumption, saving, taxes, net export and government trade
balance?
e. If autonomous import has declined by 100; what would be its effect on
planned expenditure, equilibrium level of income, changes in
consumption, saving, taxes, net export and government trade balance?
f. If both export and autonomous import have increased by 100 each,
what would be its effect on planned expenditure, equilibrium level of
income, changes in consumption, saving, taxes, net export and
government trade balance?

2. Consider an economy described by the following equations:

C = C+I+G+NX (1)
G = 1000 (2)
C = 250+0.75 (Y-T) (4)
T = 100+0.2Y (3)
I = 1000-50r (5)
M = 500+0.1Y (6)
X = 750

g. Write the aggregate demand equation by incorporating the values of the

variables given in equations (2) to (6) in Equation 1.
h. Write the saving equation

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 i. Calculate government multiplier
j. Suppose government increases its spending from 1000 to 1250, what
would be its effect on planned expenditure, equilibrium level of income,
changes in consumption, saving, taxes, net export and government trade
balance?
k. If autonomous import has declined by 100; what would be its effect on
planned expenditure, equilibrium level of income, changes in
consumption, saving, taxes, net export and government trade balance?
l. If both export and autonomous import have increased by 100 each,
what would be its effect on planned expenditure, equilibrium level of
income, changes in consumption, saving, taxes, net export and
government trade balance?
3. Suppose we have
C =Co+c1Yd
I =Ibar
G = Gbar
NX = Xbar – [Mbar+mY]
Yd = Y-(Tbar+tY-R)

a) Find multipliers for government spending, export, autonomous

investment, autonomous import, government transfer, autonomous tax
and export?
b) Write the saving function.
c) If c1 = 0.75, t=0.1, m =0, what would be the value of the above
multipliers? If m becomes 0.1, what would happen to the above
multipliers? So, is it possible to conclude that a change in marginal
propensity to consume, marginal propensity to save or marginal
propensity to import has an impact on the multiplier and the economy? In
what way?

4. In a closed economy model, a country cuts its defense spending. What is

likely to happen in the household consumption, household saving,
government balance and trade balance?
5. Assume a small open economy, which described by the following set of
equations.
With
T =tY,
M = Mbar +mY,
C = C0+c1(Y-T),
X= Xbar,
G= Gbar and
CAPB = K-bar+1/β (rd-rf), where β approaches to infinity.

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 The country follows a fixed exchange rate regime.
a. If government reduces its spending, what is likely to happen to the
equilibrium level of income, consumption, saving, tax collection, saving,
trade balance, interest rate and government balance, if (a) the exchange
rate regime is fixed; (b) if the exchange rate regime is floating?
b. If government reduces money supply with the intention of raising
domestic interest rate and attract capital inflow, what is likely to happen
to the equilibrium level of income, consumption, saving, tax collection,
saving, trade balance, interest rate and government balance, if (a) the
exchange rate regime is fixed; (b) if the exchange rate regime is floating?
c. Which policy is effective in bringing tangible changes in the economy and
in what condition?

6. Find the IS equation given the following information 6.1, 6.2 and 6.3
6.1. C = 20+0.8Yd
T = 0.3Y
G = 120
I = 150-10r
NX = 40-0.06Y
6.2. C = 20+0.8Yd
T = 0.2Y
G = 120
I = 150-10r
NX = 40-0.05Y
6.3. C = 20+0.8Yd
T = 0.2Y
G = 120
I = 150-10r
NX = 40-0.025Y
6.4. What effect do the decline in the tax rate from 0.3 to 0.2 entails
on the slope of the IS curve and also the likely effect of change in
government spending on equilibrium level of income if r = 0.10 and r
= 0.05?
6.5. What effect do the decline in the tax rate from 0.3 to 0.2 and
the propensity to import from 0.05 to 0.025 brings on the IS curve
and the likely effect of change in government spending on equilibrium
level of income If r=10% and r= 0.05%?
7. If the nominal exchange rate of a small open economy appreciates and wants
to maintain it to the previous position using tax instruments (lump-sum tax
adjustment), what would it be effective if the exchange rate regime is (a)
fixed and (b) floating and how? Would it feasible to use lump-sum tax as
policy parameter in the Mundull-Flemming model to change the equilibrium

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 level of income in (a) fixed exchange rate regime, and (b) floating exchange
rate regime.
8. Suppose that foreign countries decided to subsidize investment by instituting
what is called tax holiday up to 10 years after commencing operation
whereas Ethiopia charges profit taxes as soon as investors commence
operation. What happens to capital inflow and outflow in the country; what is
likely to happen to balance of payment if the country follows a fixed
exchange rate regime or floating exchange rate regime?
9. Assume that purchasing power parity holds between Ethiopia and Saudi
Arabia. The nominal interest rate is 15 percent in Saudi Arabia and 12
percent in Ethiopia. The real interest rate is equalized. Mohammed wants to
become rich in a short period possible by depositing his money in Saudi
Arabia. Is the decision of Mohammed correct? Why?
10. What is the direct effect of an increase in saving on income?
11. In a closed economy model, with upward slopping LM curve and
downward slopping IS curve, government has implemented a contractionary
monetary policy. What is likely to happen to the economy? Tell us the
mechanism through which the policy action affects equilibrium level of
income.
12. In a closed economy model, with upward slopping LM curve and
downward slopping IS curve, government spends on goods and services
more than before. What is likely to happen to the economy? Tell us the
mechanism through which the policy action affects equilibrium level of
income.