1. Now consider the following model and answer related questions.
Y = C + I + G + X - IM
C = 49 + 0.9DI
I = 300 - 2000r
G = 800
T = 10 + 1/3(Y)
X - IM = 60
a. If fed decides to set the interest rate at r = 0.05, how much will be the equilibrium GDP?
b. At that rate how much is budget deficit or surplus?
c. By how much GDP will change if government cuts tax rate from 1/3 to 0.20 and at the same time the Fed raises the interest rate from 0.05 to 0.06?
d. Now suppose net exports drops by 20. In order to offset its contractionary impact on GDP, Fed decides to lower the rate of interest from 0.05 to 0.04 (just like during Asian crisis). How much is your prediction for a change in GDP?
2. Consider the following model and again answer related questions.
Y = C + I + G + X - IM
C = 300 + 0.75DI where DI = Y - T
I = 600 - 1000r
G = 300
X-IM = 100
T = 0
a. How much is equilibrium level of income or output if Fed decides to set the rate of interest at 10 percent (r=0.10).
b. In an effort to cool down the economy, the Fed raises the rate of interest to r =0.15. By how much will Y change?
c. To coordinate the fiscal and monetary policies, assume government decides to balance the budget by raising taxes by 300. At the same time Fed decides to counter the contractionary effect of the tax hike and lowers the rate of interest to r = 0.05. Can you predict the change in Y?