Assume that longrun real GDP Ys800in a closed economy Consum

Assume that long-run real GDP (Y)?s8,00in a closed economy. Consumption (C)is given by: C 1000+0.662(Y-T) Investment (I) is given by I- 1,200- 100r wh is the real interest rate in percent (ie 4% not 0.04). Both taxes T) are government ending (G) are exogenously determined and equal $2000 and S2,500, respectively. a: \"What are the equilibrium values of©?/HHaHz b. What are the values of private sector saving (S,), government saving (S,), and national saving (Sa)? d. If G is increased by 500 call else equal), what are the new equilibrium values of C.I and r? Has there been crowding out? Explain d. What are the new values of S , s, and S

Solution

(a) Given Y=8000, T=2000 and G=2500

Thus equilibrium C=1000+0.667(8000-2000)=5002

The equilibrium condition is given as Y=C+I+G. We already have values of for C, Y and G. Now we have to calculate equilibrium r

8000=5002+1200-100r+2500

Thus solving for r from the above equation we get r=7.02%. Substituting this r into the equation of I, we get I=1200-100*7.02=498

Thus in equilibrium C=5002, r=7.02 and I=498

(b) Private sector saving Sp=Y-C=8000-5002=2998

Government saving Sg=T-G=2000-2500=-500

National Saving Sn=Sp+Sg=2998-500=2498

(c) If G is increased by 500, then the new equilibrium value of C remains unchanged because G doesn\'t determine C. However G crowds out private investment I because output has remained constant. It does so by competing for available loanable funds which raises the real interset rate.

From the equilibrium condition Y=C+I+G

8000=5002+1200-100r+3000. Solving for r we get the equilibrium real rate of interest as r=12.02%. At this r, the new level of investment is I=1200-100*12.02=0

Thus increase in Government expenditure fully crowds out private investment.

(d) The value of private saving Sp is stil the same because Y and C are the same. Sp=2998

Government Saving Sg=2000-3000=-1000

National Savingg Sn=Sp+Sg=2998-1000=1998

Thus both national and government saving falls.