Macroeconomics Assignment: Economic Equilibrium and Policies

This macroeconomics assignment solution analyzes an economy using given data on consumption, investment, government expenditure, exports, and imports. The solution calculates autonomous consumption, total savings, actual investment, unintended inventory investment, autonomous imports, autonomous net exports, and autonomous planned expenditure. It determines whether the economy is in equilibrium and calculates the equilibrium level of income. The assignment further explores the marginal leakage rate, expenditure multiplier, and tax multipliers. Section B delves into GDP gaps, expansionary fiscal and monetary policies, crowding-out effects, and the impact of currency depreciation on the economy, including the IS-LM model and exchange rate dynamics. The solution provides detailed calculations and explanations to understand macroeconomic concepts and policy implications.

Running head: MACROECONOMICS
Macroeconomics
Name of the Student
Name of the University
Course ID

1MACROECONOMICS
Table of Contents
Section A....................................................................................................................................2
Part 1......................................................................................................................................2
Part 2......................................................................................................................................3
Part 3......................................................................................................................................3
Part 4......................................................................................................................................4
Part 5......................................................................................................................................4
Part 6......................................................................................................................................5
Part 7......................................................................................................................................5
Part 8......................................................................................................................................5
Part 9......................................................................................................................................6
Section B....................................................................................................................................7
Part 10....................................................................................................................................7
Part 11....................................................................................................................................8
Part 12....................................................................................................................................9
Part 13....................................................................................................................................9
Part 14..................................................................................................................................10
Part 15..................................................................................................................................11
References................................................................................................................................12

2MACROECONOMICS

3MACROECONOMICS
Section A
Part 1
Standard form of consumption function is given by
C=a+ b Y d
a: Autonomous consumption
b: Marginal propensity to consume
Yd: Disposable income.
MPC=1−MPS−MPT −MPM
¿ 1−0.4−0.18−0.1
¿ 0.32
Level of income equal $520, 240.
Disposable income ( Y d )=(Y −T )
¿ $ 520,240−$ 206,700.0
¿ $ 520 ,240−$ 206,700.0
¿ $ 313540.0 million
AutonomousConumption ( a )=C− ( b × Y d )
¿ $ 171,650.0− ( 0.32 × $ 313540.0 )
¿ $ 171,650.0−$ 100332.8
¿ $ 71317.2million

4MACROECONOMICS
Part 2
Total Saving=Income−Consumption−Government Expenditure
¿ $ 520 ,240−$ 171,650.0−$ 48,660.0
¿ $ 299930.0 million
Part 3
Income levels (Y) = $520,240
Consumption Expenditure (C) =$171, 650.0 Million
Planned Investment = $118, 972.0 Million
Export expenditure (X) = $840,148.0 Million
Import expenditure (M) = $720,652.0 Million
Y =C + I+ G+ ( X−M )
¿ , 520,240=171,650.0+ I +48,666.0+ ( 840,148−720,652 )
¿ , 520,240=171,650.0+ I +48,666.0+119496
¿ , I =520,240−171,650.0−48,666.0−119496
¿ , I =180,428 .0
Actual Investment =$ 180,428.0million
Unintented inventory investment =Actual Investment −Planned Investment
¿ ( $ 180,428.0−$ 118,972.0 ) million
¿ $ 61456 million

5MACROECONOMICS
Part 4
Suppose the import function is given as
M =c+dY
c = Autonomous import
d = marginal propensity to import
Autonomousimport=M −dY
¿ $ 720,652.0− ( 0.1 × $ 520 , 240 )
¿ $ 720 ,652.0−$ 52024.0
¿ $ 668,628 million
Part 5
The net export function can be defined as
NX = A+ BY
NX: Net export
A: Autonomous net export
B: Marginal propensity to import
Net export ( NX ) =Export−Import
¿ ( $ 840 ,148.0−$ 720 ,652.0 ) million
¿ $ 119,496.0 million
Autonomous net export=NX−BY
¿ $ 119 , 496.0− ( 0.1 × $ 520 , 240 )

6MACROECONOMICS
¿ $ 119 , 496.0−$ 52024.0
¿ $ 67472.0 million
Part 6
Autonomous planned expenditure=Autonomous consumption+ Autonomous Net Export + Planned Investment
¿ $ 71317.2+ $ 67472.0+ $ 118,972.0
¿ $ 257761.2million
Part 7
The economy is not in equilibrium as there are unintended inventory investment
resulting in a higher actual investment compared to planned investment1.
Equilibrium level of income for this economy is given as
Y =C + I+ G+ ( X−M )
¿ $ 171650.0+$ 118,972.0+$ 48,666.0+ ( $ 840 ,148.0−$ 720,652.0 )
¿ $ 171650.0+$ 118,972.0+ $ 48,666.0+ $ 119496.0
¿ $ 458,784 million
Part 8
Total leakage rate=MPS+ MPT + MPM
¿ 0.4+ 0.18+0.1
¿ 0.68
1 P Agenor & P Montiel, Development macroeconomics, Princeton (N.J.), Princeton University Press, 2015.

7MACROECONOMICS
Marginal leakage rate signifies fraction of income that does not spent on
consumption. This is the proportion of income that is being saved, or taxed or spent on
import2. The combined marginal leakage rate is the sum of all the leakages incurred from
income.
Part 9
Expenditure Multiplier= 1
Total Leakages
¿ 1
0.68
¿ 1.47
Lumpsum tax multipler = −MPC
1−MPC
¿ −0.32
1−0.32
¿ −0.32
0.68
¿−0.47
Income tax multiplier= −1
1−MPC ( 1−t )
¿ −1
1−0.32 ( 1−0.18 )
¿ −1
1− ( 0.32 ×0.82 )
¿ −1
1−0.2624
2 B Heijdra, Foundations of modern macroeconomics, Oxford University Press, 2017.

8MACROECONOMICS
¿ −1
0.7376
¿−1.3557 −1.36
Section B
Part 10
Equilibrium level of GDP is computed to be $458,784 million. The natural level of
income is estimated as $460, 000. GDP gap is the difference between equilibrium level of
GDP and natural GDP. The computed GDP gap is ($460, 000 - $458, 784) million = $1216
million.
Figure 1: AD-AS model and GDP gap

9MACROECONOMICS
Figure 2: Aggregate Expenditure and GDP gap
Part 11
As the equilibrium GDP is less than potential GDP, government needs to undertake
expansionary policy measures to close the gap.
Spending multiplier=1.47
¿ , dY
dG =1.47
¿ , 1216
dG =1.47
¿ , dG= 1216
1.47
¿ , dG=827.2

10MACROECONOMICS
Part 12
Figure 3: Crowding-Out effect of government expenditure
An increase in government expenditure increases national income through the
multiplier effect. Again with increase in income money demand in the economy increases as
well. As money demand increases available money supply, there is a tendency of interest rate
to increase. Higher interest rate in turn results in a decrease in private investment. The
squeezing of private investment due to increase in public expenditure is known as crowding
out effect. Because of the adverse effect on private investment the there is a lesser multiplier
effect of government expenditure. As shown in the above figure following an increase in
government expenditure by $872.2 million, national income is likely to increase to Y2.
However, because of crowding out effect income increases only up to Y3.
Part 13
In order to close the recessionary gap, central bank should take an expansionary
monetary policy. Monetary policy expansion is taken in the form of a lower interest rate. As
interest rate decreases, there is an increase in investment which in turn increases national

11MACROECONOMICS
income. Decline in interest rate through open market operation requires central bank to
purchase government bonds from banks. As central bank purchases government bonds, it
inject money in the economy. This cause money supply in the economy to increase. As
money supply increases interest rate decrease helping to close the GDP gap.
Part 14
`Figure 4: Expansionary monetary policy and exchange rate model
The expansionary monetary policy as taken by central bank of the economy shifts the
LM curve to the right. This results in a decrease in interest rate to r1. The resulted decrease in
interest rate influences currency exchange rate as shown in the above figure. Initial demand
and supply curve of foreign exchange is shown by DD and SS curve respectively. Now,
lower interest rate discourages foreign investors to invest in the country resulting in capital
outflow3. The capital outflows reduces supply of foreign exchange reserves causing a
leftward shift of the supply curve. As a result domestic currency depreciated shown from an
increase in exchange rate.
3 M Uribe & S Schmitt-Grohé, Open economy macroeconomics, Princeton University Press, 2017

12MACROECONOMICS
Part 15
Figure 5: Depreciation of exchange rate and impact on the economy
The figure above illustrates impact of currency depreciation on the economy.
Depreciation of currency affects the IS curve by influencing relative price of export and
import. A lower value of currency means a relative low price for exported goods. This results
in an increase in export volume. Import in contrast becomes more expensive causing volume
of import to fall. Increase in export and fall in import improves trade balance resulting in an
increase in net export4. As net export increases, IS curve shifts outward to IS1. As a result
national income increases. As the economy expands, new employment opportunities are
created and unemployment falls.
4 H Johnson, Macroeconomics & monetary theory, Routledge, 2017.

13MACROECONOMICS
References
Agénor, P, & P Montiel, Development macroeconomics. Princeton (N.J.), Princeton
University Press, 2015.
Heijdra, B, Foundations of modern macroeconomics. Oxford University Press, 2017.
Johnson, H, Macroeconomics & monetary theory. Routledge, 2017.
Uribe, M, & S Schmitt-Grohé, Open economy macroeconomics. Princeton University Press,
2017.