Econ 102

Name (print clearly): __________________________

PROBLEM SET # 6 Macroeconomics

Learning Objectives: • Understand how consumption, investment and government spending determine GDP. • Understand the difference between a recessionary gap and an inflationary gap. • Develop the intuition behind the multiplier. • Examine how fiscal policy can be used to fix the economy and how the federal budget will be

affected.

1) Use the following data to answer the questions below.

𝐶 = 1500 + .9(𝑌 − 𝑇�) 𝐺 = 500 𝐼𝑃 = 2,750 𝑇� = 500

𝑌𝑓 = 50,000 a) Using the data from above, explain the current state of the federal budget?

b) Calculate the MPC and the MPS. Interpret both numbers.

c) Find the economy’s current equilibrium, that is 𝑌∗ and both current consumption 𝐶∗ and

current savings 𝑆∗.

d) Graph both the current equilibrium (𝑌∗) and the full employment equilibrium (𝑌𝑓) for the

above economy.

e) Based the current equilibrium, where is the economy operating at on the production

possibilities frontier, the business cycle and the Philips curve?

f) Based on the data (𝑌∗ 𝑎𝑎𝑎 𝑌𝑓) is the economy currently experiencing a recessionary gap or inflationary gap? How does the current unemployment rate compare to the natural rate of unemployment? Explain.

g) What is the size of the government expenditure multiplier? How does it relate to the round by

round effect?

h) Assume fiscal policy is used to get the economy back to full employment. By how much and in what direction should government spending be changed to get the economy back to full employment?

i) Update all of the previous graphs to reflect the change in government spending.

j) How will the change in government spending affect consumption and savings? Calculate the new levels of consumption and savings.

k) How will the change in government spending affect the budget and the national debt? If the government has to borrow money to fix the economy, explain the process.