Question 1 (2 + 2 + 2 + 2 + 2 = 10 marks)
Exhibit A C=100+c Y Exhibit B I =´I −b i ❑
D Exhibit C M /P=800 ´
Y❑
D =Y −tY + TR ´I =300 L=620+ k Y −h i c=0.8 b=20 k =0.2 h=20 t=0.2 5 ´I =200
´
G=300
´
TR=100
´ =0
NX ´
BS=tY −G− TR
Y ¿❑=2000
(a) For the economy shown in Exhibit A calculate the expenditure multiplier and equilibrium
income. (b) For the economy shown in Exhibit A calculate the budget surplus (BS). Identify the structural
¿ and cyclical components of the BS with regard to the potential output level ( Y ❑=2000 ). (c) By how much would the government have to change spending (G) to shift output to potential
¿ output ( Y ❑=2000 ). (d) An alternative to changing government spending to reach equilibrium is to change taxes ( t ). Calculate the tax rate ( t ) which will shift output to potential output (
¿ Y ❑=2000 ). (e) Consider the impact on the budget surplus (BS) of the changes suggested in (c) and (d). If the
government wished to implement the policy change which led to the smallest possible
structural budget surplus/deficit which policy would you advocate; changing taxes or
government spending? Question 2 (2 + 2 + 2 = 6 marks)
Let us now suppose we have an economy characterized as in Exhibit A. However, we make two
changes. First, suppose that investment expenditure is now described by the equations in Exhibit B.
Second, let us introduce a money market which is described by the equations in Exhibit C.
(a) Derive the equation for the IS curve and the equation for the LM curve. (b) Using the IS and LM curves from the previous question derive the equilibrium interest rate
and income. (c) In Exhibit A consumption spending is not driven by the interest rate. Suppose now that
consumption is determined by the following equation: ´ c Y ❑D−ai
C=C+
with a>0 . Derive an algebraic expression for the IS curve given this and comment on the slope of this
curve compared with the case where a=0 . Question 3 (2 + 2 = 4 marks)
The data in the table below illustrates some key economic indicators for the United States economy
during the period of the global financial crisis (GFC). Year GDP
(annual %
change) 2005
2006
2007
2008
2009
2010
2011
2012
2013 3.35
2.67
1.78
-0.29
-2.78
2.53
1.60
2.22
1.68 Federal
Funds Rate
(% at yearend)
4.25
5.25
4.25
0.00
0.00
0.00
0.00
0.00
0.00 Unemp.
Rate
(%)
5.08
4.61
4.62
5.80
9.28
9.61
8.93
8.08
7.38 Consumption
(annual %
change)
3.5
3.0
2.2
-0.3
-1.6
1.9
2.3
1.5
1.5 House
Prices
(annual %
change)
16.04
5.88
-6.24
-15.30
-10.10
-1.18
-2.81
4.75
10.05 Investment
(% of GDP) 23.22
23.33
22.35
20.79
17.51
18.39
18.55
19.35
19.76 Budget
Surplus
(% of GDP)
-3.13
-2.04
-2.86
-6.68
-13.15
-10.93
-9.59
-7.88
-4.39 (Sources: IMF WEO Database Oct 2016; BIS; BEA; Federal Reserve)
(a) With regard to the data in the table, and your research, use the IS-LM framework to discuss
the nature of the shock(s) that hit the economy during the GFC. [Instructions: Your answer
should discuss the movements in the IS and LM curves. It is not necessary to draw pictures.
Maximum 150 words. You must enter the word count of your answer.] (word count: ?)
(b) With regard to the data in the table, and your research, use the IS-LM framework to discuss
the fiscal policy response by government and monetary policy response by the central bank
to the GFC. [Instructions: Your answer should discuss the movements in the IS and LM
curves. It is not necessary to draw pictures. Maximum 100 words. You must enter the word
count of your answer.] (word count: ?)

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