Assume that in 2011, the following prevails in the Republic of Nurd:
Y = $200 G = $0
C = $160 T = $0
S = $40
I (planned) = $30
Assume that households consume 80 percent of their income, they save 20 percent of
their income, MPC = .8, and MPS = .2. That is, C = .8Yd and S = .2Yd.
a. Is the economy of Nurd in equilibrium? What is likely to happen in the coming months
if the government takes no action?
b. If $200 is the “full-employment” level of Y, what fiscal policy might the government
follow if its goal is full employment?
c. If the full-employment level of Y is $250, what fiscal policy might the government
d. Suppose Y = $200, C = $160, S = $40, and I = $40. Is Nurd’s economy in equilibrium?
e. Starting with the situation in part d, suppose the government starts spending $30 each
year with no taxation and continues to spend $30 every period. If I remains constant, what
will happen to the equilibrium level of Nurd’s domestic product (Y)? What will the new
levels of C and S be?
f. Starting with the situation in part d, suppose the government starts taxing the
population $30 each year without spending anything and continues to tax at that rate
every period. If I remains constant, what will happen to the equilibrium level of Nurd’s
domestic product (Y)? What will be the new levels of C and S? How does your answer to
part f differ from your answer to part e? Why?