Let: Y  C + I + G + (X - M) C = 75 + .8YD I = 110 G = 180 X = 40 M = 15 + .04Y T = -250 + .2Y Problem 1) Compute the value of equilibrium of GDP (Y0)--illustrate with an income expenditure diagram. 2) Calculate the balance of trade on current account when income assumes the value you computed in (1) above. 3) Calculate the change in imports (M) resulting from a $20 decrease in exogenous investment (I). 4) Suppose potential GDP (Yf ) is equal to $1,575. Assuming the economy is in equilibrium at the value of income you computed in (1) above, calculate the change in government spending required to achieve a full employment equilibrium.

1. To solve for equilibrium national income (Y0) First, solve for A: A = Ca - cTa + Ia + GA + (Xa - Ma) A = 75 - [(.8)(-250)] + 110 + 180 + (40 - 15) = 590 Thus, we have:

The graph AE AE = Y AE 590 450 1,475 Y

BPCA = X - M = 40 - {15 + [(.04)(1475)]} = -34 2. To calculate the current account balance (BPCA): BPCA = X - M = 40 - {15 + [(.04)(1475)]} = -34 3. To calculate the change in imports (M) resulting from a $20 decrease in exogenous investment: M = m Y = .04 Y Thus, M = (.04)(-50) = -2

4. AE AE’ AE = Y AE 100 = Ga  2.5  Ga = 40 Y0 1,575 1, 475 Y 630 590 450 1,575 1, 475 Y

A Deterioration of consumer confidence, ceteris paribus LM 1 2 IS Interest rate LM 1 2 IS IS’ National income (Y)

B Increase in the money supply, ceteris paribus LM LM’ 1 2 IS Interest rate LM LM’ 1 2 IS National income (Y)

Upward revision of Qi’s to be capturedby spending for tangible capital goods, cteris paribus Interest rate LM 2 1 IS’ IS National income (Y)

Increase in the asset demand for money at every interest rate, ceteris paribus. LM’ LM 2 1 IS National income (Y)

G Decrease in government spending, ceteris paribus LM 1 2 IS IS’ Interest rate LM 1 2 IS IS’ National income (Y)

H Increase in the supply price of capital goods, ceteris paribus. LM Interest rate LM 1 2 IS IS’ National income (Y)