1. Calculate the equilibrium level of output/income in the economy. (Hint: remember to fill in taxes in the consumption function!)

Y = C +I+G+NX
Y = 6000 + .8(Y-15000) + 12000 + 17000 -500
Y = 22,500 + .8Y
Y = 112,500
 
2. Determine the value of the government spending multiplier and the tax multiplier.

multiplier for G:  1/(1-MPC) = 1/(1-.8) = 5
multiplier for T:  MPC/(1-MPC) = .8/(1-.8) = 4
 
3. Suppose the government is considering two proposals to balance the budget:
1. increase T until T=G, OR
2. decrease G until T=G

using the multipliers:
change in Y = 2000 x 4 = 8000  if taxes rise by 2000
change in Y = 2000 x 5 = 10,000  if G falls by 2000

so the tax hike has a smaller impact on output

1. How much is the bank required to hold as reserves, given its deposits of $1200?

(.05) x 1200 = 60
 
2. How much are its excess reserves?

excess reserves = total reserves - required reserves
excess reserves = 200 - 60 = 140
 
3. Suppose a depositor comes in and deposits $100 in cash. Show the banks new balance sheet below. Now how much are excess reserves?

deposits rise to $1300
reserves rise to $300
loans stay at $1000

excess reserves = 300 - (1300)(.05) = 300 -65 = 235
 

4. Calculate the money multiplier

= 1/reserve requirement = 1/.05 = 20
 
5. Consider the $100 deposit made in (c). How much in new deposits can be created from this $100 deposit?

new deposit creation = excess reserves x money multiplier
new deposit creation = 95 x 20 = 1900

Ye is equilibrium output, while Yf is full employment output

• Describe the condition of the economy above.

Equilibrium output is above full employment so there is an inflationary gap.
 
• Describe the appropriate fiscal policy in this situation. Show the impact on the graph above.
• The AD curve will shift left in the graph above due to either an increase in taxes or decrease in government spending