Due Monday, Oct. 15, in Lecture, Uris G-01

Economics 102Professor McClelland

Fall 2007

Problem Set #5

DUE MONDAY, OCT. 15, IN LECTURE, URIS G-01

Problem sets are to be turned in at the beginning of the lecture.

Boxes will be provided at the back of Uris G-01.

Place your problem set answers in the box with your TA’s name and section on it.

No credit will be given for late submissions.

1. Suppose the consumption function is linear of the form C = 1000 + 0.7(Y – Tx).Assume now that the new tax law reduces the taxes of all taxpayers by 10%. Then which one of the following statements is FALSE?
   

a)Disposable income increases.

b)Consumption increases because disposable income increases.

c)The marginal propensity to consume increases because disposable income increases.

d)The marginal propensity to consume remains unchanged.

1. If total expenditure (or C + I + G) exceeds total output produced (or NDP), then:

a)inventories will build up above desired (or planned) levels, so firms will cut production.

b)inventories will fall below desired (or planned) levels, so firms will cut production.

c)inventories will fall below desired (or planned) levels, so firms will increase production.

d)inventories will build up above desired (or planned) levels, so firms will increase production.

1. Assume that if the government spending (G) rises by $100 billion, then the equilibrium level of national income (Y) increases by $700 billion. Given this information, we know that the tax multiplier equals:

a)-7

b)6

c)7

d)-6

OVER

Economics 102Problem Set #5

1. Assume an economy in which:
   (a) there is no foreign trade (that is, no exports and no imports),
   (b) investors always want to spend $700 billion, or
   ,
   (c) government always levies a tax of $150 billion and spends all the resulting revenue, or
   G = 150 = Tx,
   (d) consumers always spend $250 billion plus 90% of disposable income.

show all your work.

1. What is the consumption function for this economy?

1. What will be the equilibrium level of income? Why is this an equilibrium?
   
2. Assume that when this equilibrium level of national income is reached (your answer to II), the economy is still experiencing inflationary pressures. To combat this inflation, the government wants to increase taxes in order to cut the equilibrium level of national income to $9,200 billion. (Government spending will remain unchanged at $150 billion.) How large must this tax increase be?
   
3. Suppose that consumers respond to this new policy by paying all of the tax increase out of savings (i.e. consumption is not altered by the tax increase). Now when the tax is introduced, what is the new equilibrium level of national income?Use a circular flow diagram to explain your answer.