1. You are given the following information about a fix-price economy:

C = 150 + 0.8 Yd

Yd = Y - T

T = 5 + 0.5 Y

I = 54

G = 150

X = 50

IM = 0.2 Y

AE = C + I + G + X - IM

where Y is national income (GDP), Yd is disposable income, C is consumption, I is investment, G is government spending, T is total taxes, X is total exports, IM is total imports and AE is aggregate expenditure.

1.1 Fill in the blanks in Table 1 below:

Table 1

Y    T         Yd     C I G X-IM      AE





1.2 Calculate the equilibrium level of real GDP. Illustrate your answer in an income-expenditure diagram.

1.3 What are the government's budget balance and the trade balance at the equilibrium GDP? Illustrate your answers in diagrams.

1.4 Assume the potential GDP is 600, and the government decides to set this level as its income target. By how much must the government increase/decrease its expenditure to achieve this target? What will be the impact effects of this change in government expenditure on the budget balance and the trade balance? What is the size of the multiplier?

1.5 Suppose the economy attains its potential GDP of 600 after the government raises its expenditure. The government, however, decides to raise a lump-sum tax to cover the extra spending, what will be the effects on the equilibrium national income? Will there be any output gap at the new equilibrium national income? Illustrate your answers in a diagram.

2. If an economy is experiencing weak demand and strong deflationary pressures because it has experienced a negative shock which sharply reduces aggregate demand, compare and contrast the effectiveness of the following two policies in reducing deflationary pressures:

(a) An increase in government spending (fiscal policy)

(b) An expansion of the money supply (monetary policy)