Keynesian ModelsAggregate Expenditure (AE) Model, AnalyticalAre there any restrictions on the possible values of "7016C and MPC? If so, list them and briefly explain why these restrictions are imposed.Write out the aggregate expenditure equation AE(Y). Is it linear in Y? If so, list the slope and y-intercept terms. Draw a graph of AE(Y) versus Y.Write equilibrium output level Y* as a function of T, TR, MPC, "7016C, I, and G. (hint: write down the equilibrium condition for AE model, i.e. AE(Y*)=Y*, and solve for Y*)Define tax multiplier MTY*T and government expenditure multiplier MGY*G (in calculus terms, MT=Y*T and MG=Y*G). Given your expression for Y* from the previous part, write MT and MG, the fiscal policy multipliers, in terms of constants. Which multiplier is larger in magnitude? (hint: the fiscal policy multipliers are the coefficients on the T and G terms in the equation for equilibrium output Y* that you derived previously)Briefly explain how the aggregate expenditure model reaches equilibrium (Y*,C*) from any nonzero initial level of output Y0. (hint: you answer should talk about how firms respond to unexpected changes in inventories under three cases: Y0<Y*, Y0=Y*, and Y0>Y*; stating the goal of the firm may help)From this part forward, assume the following: "7016C=175, MPC=45, I=200, G=T-TR=250. If Y=2000, what is planned aggregate expenditure? Given your answer, would you expect equilibrium output level Y* to be higher or lower than Y=2000?What is the equilibrium level of output Y*? Is it consistent with your guess in the previous part?Now, suppose that G is reduced to 200 units with T unchanged. What is the new equilibrium output level? Calculate YG. Is your result consistent with the government expenditure multiplier MG computed in part (1.1.4)?Now, suppose that T is reduced by 20 units with G=250 and TR unchanged. What is the new equilibrium output level? Calculate YT. Is your result consistent with the tax multiplier MT computed in part (1.1.4)?Aggregate Expenditure Model, ComputationalTranslate the AE model formulas above into Excel formulas in a spreadsheet, and then run the model for t=0,1,…,500.Graph Yt, Ct, It, and Gt versus t (time) in a single graph, if possible. Print your graph(s) out. What trends do you observe?Based on your answer to the previous part, which statement is correct: (1) Y0<Y*; (2) Y0=Y*; (3) Y0>Y*?Graph Tt, TRt, and Spublic,t=Tt-Gt-TRt versus t (time) in a single graph, if possible. Print your graph(s) out. What trends do you observe? Describe the government budget balance over time.Graph Spublic,t, Sprivate,t=Yt-(Tt-TRt)-Ct, and NSt=Yt-Ct-Gt versus t (time) in a single graph, if possible. Print your graph(s) out. What trends do you observe? Describe household saving behavior over time.Define the household savings rate as st=Sprivate,tYt(100) and the national savings rate as st=NStYt(100). Graph st and st versus t in a single graph, if possible. Print your graph(s) out. What trends do you observe?Mechanics of the Aggregate Expenditure ModelAssume an aggregate expenditure function of form AE(Y)=a+bY, where a>0 and 0<b<1. Draw a graph of the aggregate expenditure model that includes the 45 line and the aggregate expenditure function in AE versus Y space. Your graph should be labeled clearly and completely.Assume that initial output level Y0 is less than the equilibrium level of output Y* (Y0<Y*). Also, let's say that the full employment level of output YFE, associated with the natural (full employment) level of unemployment, is such that Y*<YFE. Reproduce your graph in the previous part, adding vertical lines denoting Y0 and YFE.Briefly describe how the economy transitions from initial output Y0 to equilibrium output Y*. Your answer should talk about how the following economic variables are affected: (1) the level of employment; (2) the level of inventories; (3) unexpected changes in inventories; and (4) the level of output.The government wants to attain the full employment level of output, YFE, in the short-run by adjusting the level of government expenditure G. Based on your diagram from part (1.3.2), how should the government change G to achieve their goal? On your graph, show the effects of an appropriate change in G. Label G and Y as a result of the new fiscal policy. What is the new level of output?Based on your answer to the previous part, which statement is correct: (1) Y<G; (2) Y=G; (3) Y>G? What is the government spending multiplier MG=YG in this case?When the government implements their new fiscal policy, what happens to the economy in terms of unexpected changes in inventories and output? What if businesses anticipate the government's change in fiscal policy?AD / AS ModelAggregate Demand / Aggregate Supply ModelIf the economy is initially in long-run equilibrium, what are the values of PLR* and YLR*?Now suppose a supply shock moves the short-run aggregate supply curve to PSR=4 (still horizontal). What is the new short-run equilibrium (PSR*,YSR*)?If the aggregate demand and long-run aggregate supply curves are unchanged, what is the new long-run equilibrium (PLR*,YLR*) after the supply shock?Suppose that after the supply shock, the Federal Reserve wants to hold output at its long-run level. What level of the money supply M would be required to achieve this in the short-run?From this part forward, consider the generic aggregate demand - aggregate supply model with three curves: AD, SRAS, and LRAS. Assume that the economy starts in long-run equilibrium. Additionally, assume that the short-run aggregate supply curve is horizontal in P versus Y space. In a carefully labeled graph with these three curves, diagram the effect (both short-run and long-run) of an increase in expected future corporate profits. Your graph should identify two equilibrium points, short-run equilibrium (PSR*,YSR*) and long-run equilibrium (PLR*,YLR*). Briefly describe how the economy transitions from short-run to long-run equilibrium. Draw arrows along the transition path.Now assume that the short-run aggregate supply curve is upward-sloping in P versus Y space, but not vertical, with a slope near one. Continue to assume that the economy starts in long-run equilibrium. Repeat (2.1.5), but diagram the effect of an unexpected increase in the price of oil.Assignment #5 Answer Key∗Econ 102: Introductory MacroeconomicsMay 5, 2010Directions: Turn in the homework to your TA’s box before lecture. Please legibly write your name, TAname, and section number on
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