The following equations describe a Keynesian model of the economy.Cd = 500 + 0.5(Y - T) - 100rId = 350 - 100rL = 0.5Y - 200i?e = 0.05, G = T = 200, 
= 1850M = 3560(a)Find the full-employment equilibrium values of the real interest rate, consumption, investment, and the price level.(b)Suppose government purchases decline to 175, with no change in taxes. What happens to the real interest rate, output, consumption, and investment in the short run (in which the price level is fixed)? What happens in the long run to the real interest rate, consumption, investment, and the price level?(c)Suppose instead that government purchases rise to 225, with no change in taxes, starting
from the equilibrium in part (a). What happens to the real interest rate, output, consumption, and investment in the short run (in which the price level is fixed)? What happens in the long run to the real interest rate, consumption, investment, and the price level?
What will be an ideal response?
| (a) | Sd = Y - Cd - G = 0.5Y - 400 + 100r - G. |
With G = 200 and Y = 1850, r = 0.125. Then C = 1312.5 and I = 337.5.
3560/P = (0.5 × 1850) - (200 × .175) = 925 - 35 = 890, so P = 4.
| (b) | With P = 4, the LM curve is 3560/4 = 0.5Y - 200r - (200 × 0.05), or 0.5Y = 900 + 200r. Combining |
For G = 175, Y = 1825, so r = 0.0625, C = 1306.25, I = 343.75 in the short run.
In the long run, Y = 1850, so r = 0, C = 1325, I = 350, P = 3.891.
| (c) | For G = 225, Y = 1875, so r = 0.1875, C = 1318.75, I = 331.25 in the short run. |
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Output prices are irrelevant for a firm as it is calculating its cost curves.
Answer the following statement true (T) or false (F)
Increases in real GDP are considered the best measure of increases in living standards, because they measure:
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