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Econ 251: Principles of Macroeconomics

WORKSHEET ON KEYNESIAN DEMAND MANAGEMENT

The economy of Trickstoland is currently producing $450 billion of output, while enduring 12% cyclical unemployment. The natural rate of unemployment in Togoland is 10%. Trickstoland is a labor-surplus economy, therefore there is considerable amount of labor resources in the economy.

a) Given this background, what is Trickstoland’s potential GDP, and what is the inherent GDP gap?

b) Trickstoland’s economy is open to trade with the outside world, and the economy’s personal consumption expenditure is estimated as follows:

C = 400 + 0.95 *Yd. Its imports behavior is described by the equation: M = 120 + .25 Yd. Investment and government spending are autonomous, whereas exports is exogenously determined by foreign buyers. Note that disposable income, =(Y – T), where T is the total tax amount paid form all incomes earned.

c) From the equilibrium GDP equation in question (b) above, determine the government expenditure d(GDP)/dG multiplier, investment expenditure d(GDP)/dI, and tax [d(GDP)/dT] multipliers.

d) Suppose the government of Ttrickstoland decides to eliminate the GDP gap by a combination of a tax reduction and government spending, both of which constitute fiscal policy. Given the government expenditure and the tax multipliers you have calculated above, break down the GDP gap, and determine the amount of increase in government spending and tax reduction required to close the GDP gap.