Consider an economy with no foreign trade and no transfer payments
whose consumption function is given as
C = 100 + 0.9(Y ? T).
(a) Initially let G = 800, T = 800, and I = 300. What is the level of Y? Assuming
that taxes follow the simple function, T = ?Y, what is ??
(b) Holding ? constant, what is the effect on Y of increasing G by 100 to 900?
(c) What is the effect ceteris paribus on Y of decreasing T by 100? At what
value must the government set ? to achieve this tax cut?
(d) Explain why the effects in (b) and (c) are different.
(e) Suppose that the government wanted to maintain a balanced budget and
increased both G and T by 100. What would be the effect on Y? What ?
would it need to choose to keep the budget balanced?