Philip Leatherwood, Lecturer

Kazakhstan Institute of Management, Economics, and Strategic Planning

17 January, 2001

1. Consider a simple economy in which only three items are in the CPI: food, housing, and entertainment. In the base period (1987) the household consumed the following quantities at the then prevailing prices:

1. Define the consumer Price Index
2. Assume the basket of goods is as given in the table. Calculate the CPI for 1994 if the prices in 1994 are as follows: food, $30; housing, $ 20; entertainment, $ 6.
3. Show that the change in the CPI relative to the base year is a weighted average of the individual price changes, where the weights are given by the base year expenditure shares of the various goods.

2. Assume that the GDP is $6000, personal disposable income is $5,100, and the government budget deficit is $200. Consumption is $3,800 and the trade deficit is $100.

1. How large is saving?
2. What is the size of investment?
3. How large is government spending?

3. Show that a country that spends more than its income must have an external deficit.

4. Consumption = C = 100 + 0.8Yd

Investment = I = 50

Government Spending = G = 200

Transfers = Tr = 62.5

Tax Rate = t = 0.25

1. What is the equilibrium level of income?
2. What is the value of the multipier?
3. Why is the multiplier less than when tax is a constant?

5. C = 50 + 0.8Yd

I = 70

G = 200

Tr = 100

t = 0.2

1. What is the equilibrium level of income? What is the multiplier?
2. What is the budget surplus?
3. Calculate the new equilibrium income and multiplier if t increases to 0.25.
4. What is the change in the budget surplus? Would the change in the budget surplus be more or less if C = 50 + 0.9Yd?
5. Explain why the multiplier is 1 when t = 1.

6. Exports = X, Imports = M = Q + mY, where m is the marginal propensity to import.

NX = net exports.

1. Write an algebraic expression for the trade balance and show in a diagram net exports as a function of the level of income.
2. Show the effect of a change in income on the trade balance, using your diagram. Show the effect of a change in exports on the trade balance, given income.
3. The equilibrium condition is that aggregate demand for domestic goods be equal to supply. Aggregate demand for our goods includes exports, but excludes imports. Thus: Y = C + I + NX. Using your expression for net exports from part a, derive the equilibrium level of income.
4. What is the effect of a change in exports on equilibrium income? Interpret your result and discuss the multiplier in an open economy.
5. Show the effect of an increase in exports on the trade balance.

7. IS-LM model. (Consider i as a whole number interest rate.)

C = 0.8(1 – t)Y

t = 0.25

I = 900 – 50i

G = 800

L = 0.25 – 62.5i

M/P = 500

1. describe the LM curve
2. define the LM curve
3. describe the IS curve
4. define the IS curve
5. what are the equilibrium levels of income and interest
6. What conditions are satisfied at the intersection of the IS and LM curves.

8. Using the system described above,

1. What is the value of the expenditures multiplier?
2. How does a change in G affect income?
3. How does a change in G affect equilibrium interest?
4. Explain the difference between your answers to a and b.

9. a. Why does a horizontal LM curve imply that fiscal policy has the same effects on the economy as in the income-expenditures model?

b. Under what circumstances might the LM curve be horizontal?