PROBLEM SET

Dongpeng Liu

Department of Economics

Nanjing University

GDP, GENERAL PRICE LEVEL AND INFLATION

Consider an economy producing bread and cars. Please find

the data in the table below.

Take year 2000 as the base year. Please calculate the nominal GDP,

real GDP and GDP deflator in 2000 and 2001.

The representative basket of goods contains 0.1 car and 500 pieces

of bread. Take year 2000 as the base year, please calculate the CPI

in 2000 and 2001.

Please calculate the inflation rates from 2000 to 2001 based on GDP

deflator and CPI. Comment on your results.

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Goods Produced

2000 2001

Quantity Price Quantity Price

Cars 100 50,000 120 60,000

Bread 500,000 10 400,000 20

DECOMPOSITION OF TOTAL EXPENDITURE

Categorize the following expenditures:

US Air force bought an F/A-18 from Boeing

Hainan Airlines bought a 777 from Boeing

United Airlines bought a 777 from Boeing

Boeing produced a 777 to be sold in the next year

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INCOME EXPENDITURE MODEL

An economy can be represented by

𝐶 = 160 + 0.6 𝑌 − 𝑇𝐼 = 150𝐺 = 150𝑇 = 100

Based on the income expenditure model, please calculate

Equilibrium output

Disposable income

Total consumption

If G = 250 instead, please calculate the equilibrium output

and the multiplier of government expenditures

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AUTOMATIC STABILIZER

Up to now, we have been assuming that G and T are independent

from total income. Nevertheless, real world tax burdens are often

income related. As income increases, so do taxes collected. Now,

let’s contemplate how the automatic response nature of taxes can

affect total output. Consider the model below:

𝐶 = 𝑐0 + 𝑐1 𝑌 − 𝑇𝑇 = 𝑡0 + 𝑡1𝑌

Assume that G and I remain constant and the economy is closed.

Obviously, 𝑡1 is between 0 and 1.

Based on the income expenditure model

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AUTOMATIC STABILIZER

Equilibrium output

When 𝑐0 (to some degree, 𝑐0 exhibits consumer confidence)

changes, what is the corresponding multiplier? In which case is

the economy more sensitive to changes of 𝑐0, when 𝑡1 = 0 or 𝑡1 > 0?

Why do we call this tax regime as the “automatic stabilizer”?

Suppose the policy maker prioritize balanced government budget

over other goals, in other words, G = T all the time. Now,

given a decrease of 𝑐0, the government will cut spending to balance the budget. Will the taxes still automatically

stabilize the economy? Why?

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MONEY MARKET

Suppose the money demand function is

𝑀

𝑃= 1,000 − 10,000𝑖.

The nominal money supply is 1000 and the general price level is 2.

What is the equilibrium interest rate

Suppose general price level remains constant. If nominal money

supply increases from 1,000 to 1,200, what will be the new

equilibrium interest rate?

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IS-LM MODEL

Which of the following statements is/are correct?

Since the goods market equilibrium condition implies the

negative relationship between taxes and total output, the IS

curve is downward sloping

If government expenditures and taxes increase simultaneously by

the same amount, IS curve will not shift

LM curve is upward sloping because higher output requires

higher money supply

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IS-LM MODEL AND MONETARY POLICIES

Use the IS-LM model to predict the effects of the following

shocks to income, interest rate, consumption and investment. If

the federal reserve would like to keep equilibrium output at the

before-shock level, what shall it do?

After a new high-speed computer chip was invented, many firms

updated their computer systems

A wave of credit card fraudulence makes people more willing to

use cash instead of credit cards

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IS-LM MODEL AND MACROECONOMIC POLICIES

Consider the following IS-LM model

𝐶 = 200 + 0.5 𝑌 − 𝑇𝐼 = 150 − 500𝑖

𝐺 = 250𝑇 = 200

𝑀

𝑃= 2𝑌 − 8,000𝑖

𝑀

𝑃= 1,600

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IS-LM MODEL AND MACROECONOMIC POLICIES

Deduct the IS curve

Deduct the LM curve

Calculate the equilibrium output and interest rate

Calculate the equilibrium consumption and investments. Show that the sum of C, I and G equals Y

Now, assume that M/P = 1,700. Calculate the equilibrium output, interest rate, consumption and investments. Explain the effects of an expansionary monetary policy.

Now, assume that M/p = 1,600 and G = 275. Comment on how expansionary fiscal policies affect equilibrium output, interest rate, consumption and investments

Calculate the size of the crowding-out effect

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IS-LM MODEL AND POLICY MIX

Propose a policy mix to achieve the goals in the following

scenarios

Increase Y while keeping i constant

Increase Y while reducing budget deficits. What will happen to

i? how about investments?

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IS-LM MODEL AND POLICY MIX

If the policy makers decide to change the composition of GDP by

reducing consumption and increasing investments while making

total output unchanged, what policy mix should be adopted? Use an

IS-LM figure to exhibit your proposal.

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