ECO 2142 University of Ottawa Macroeconomics Theory Problems


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ECO 2142 – Macroeconomic Theory I
Department of Economics, University of Ottawa
Prof: Yazid Dissou
Assignment 1 – Online submission due for May 18, 2020 at 20:30
The system will not accept late submissions
Note: In the current assignment several mandatory problems are proposed on purpose in order to give you a variety of questions for practice
and for a better understanding of the topics covered. Start working on
the assignment early.
• Download the assignment from Brightspace and write it.
• You are strongly advised to write with a pen or a dark pencil.
• After you finish writing the exam you should: o Make sure your
sheets are in order.
• Scan (or take a picture of) the sheets vertically and on a flat area.
• Upload your scanned copy by Monday May, 18th at 20:30.
• No late submission will be accepted by the system.
Problem 1 (15 points)
The following activities took place in an imaginary economy last year (see
the table below):
1. GDP at market prices. Which approach to measuring GDP did you
use? (5 points)
2. Personal disposable income (3 points)
3. Private saving (3 points)
4. The government’s budget deficit (2 points)
5. Leakages and injections. Are they equal? (2 points)
Wages paid to labour
Consumer expenditure
Taxes paid by households
Transfer payments
Total profits made by firms
Profits retained by firms
Interest earned by households
Rent received by households
Taxes paid by firms
Exports of goods and services
Government expenditures on goods and services
Imports of goods and services
Problem 2 (15 points)
Money demand in an economy in which no interest is paid on money is:
= 5000 + 0.2Y ? 1000i
1. You know that P = 100, Y = 1000, and i = 0.10. Find real money
demand, nominal money demand, and velocity. (5 points)
2. The price level doubles from P = 100 to P = 200. Find real money
demand, nominal money demand, and velocity. (5 points)
3. Starting from the values of the variables given in part (1) and assuming that the money demand function as written holds, determine how
velocity is affected by an increase in real income, by an increase in the
nominal interest rate, and by an increase in the price level. (5 points)
Problem 3 (30 points)
On Sun Island, a closed economy, the consumption function is
c = 1 + 0.75(y ? t) billions of 1992 dollars.
The government of Sun Island levies taxes of $1 billion a year and buys
goods and services worth $1 billion a year. Investment on Sun Island is $0.5
billion a year.
1. Calculate the equilibrium level of real GDP . (3 points)
2. Calculate total leakages from the circular flow of income and expenditure. (2 points)
3. Calculate total injections into the circular flow of income and expenditure. Do injections equal leakages? (2 points)
4. Calculate the multiplier. (3 points)
5. If investment increases by $0.25 billion a year, what is the change in
real GDP? (3 points)
6. Go back to the initial equilibrium level of GDP. The government plans
to increase its expenditures on goods and services by $0.25 billion a
year. What are the resulting changes in consumption and saving? (3
7. Explain the adjustment process to the new equilibrium. (3 points)
8. How does the government’s expenditures on $0.25 billion worth of
goods and services get financed? (3 points)
9. Show that leakages from the circular flow equal injections into it. (3
10. Go back to the initial equilibrium expenditure. The government plans
to increase expenditures on goods and services by $0.25 billion and to
finance its expenditure by an increase in autonomous taxes. What is
the new equilibrium expenditure? (5 points)
Problem 4 (20 points)
In a closed economy, the consumption function is:
c = 1.15 + 0.75(y ? t) billions of 1992 dollars.
The tax function is:
t = 0.1y + 0.1 billions of 1992 dollars.
Planned investment is $1 billion and planned government expenditures
are $1.5 billion. Calculate:
1. The equilibrium level of real GDP. (4 points)
2. Consumer expenditure (4 points)
3. Saving (3 points)
4. The investment multiplier (3 points)
5. The government budget deficit (3 points)
6. The leakages from and injections into the circular flow of income and
expenditure. Do leakages equal injections? (3 points)
Problem 5 (20 points)
Balanced budget multiplier: Consider the following simple model with investment and government spending exogenous.
Y = C+I+G
C = a + bYd
Disposable income Yd is given by Y ? T, where T is total taxes. Suppose
that taxes are not directly related to income so that T can be increased or
decreased independently of income.
1. Derive the expression for the change in equilibrium level of income ,
Y, associated with an increase in taxes T. Show the results graphically
and algebraically. What is the tax multiplier? That is, what is ?Y/?T?
(10 points)
2. Now increase government spending G and taxes T by the same amount.
For this change the government budget deficit G ? T does not change.
That is, if the budget was balanced before, it will still be balanced.
What happens to the equilibrium level of income, Y, in this case? Perhaps surprisingly it increases. Calculate by how much. That is, using
algebra calculate?Y/?G, setting ?G = ?T. The result is called the
balanced budget multiplier. (10 points)

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Explanation & Answer:
5 Problems Solutions

Gross domestic product

economic activities

Macroeconomics Theory

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