Consider The Following Open Economy

Consider The Following Open Economyc 1000 08ydi 500g 400t 3

Considering the open-economy model with the specified parameters: Consumption (C) = 1000 + 0.8YD, Investment I = 500, Government Spending G = 400, Taxes T = 300, Exports EX = 400, and Import Marginal Propensity (IM) = 0.05, the task involves a series of macroeconomic calculations. These include determining equilibrium output, marginal propensities, multipliers, effects of fiscal policy changes, and analyzing the impact of simultaneous shifts in government spending and investment, all within the framework of the specified parameters.

Paper For Above instruction

In analyzing an open economy with the given parameters, the primary goal is to understand equilibrium output and how fiscal and monetary policies influence national income. This paper will detail the calculation of equilibrium output, the marginal propensities to save and import, fiscal multipliers, and the effects of policy adjustments within the context of the model provided.

Determining the Equilibrium Output

The equilibrium output in an open economy is achieved when aggregate demand (AD) equals total output (Y). For an open economy, aggregate demand comprises consumption (C), investment (I), government spending (G), and net exports (NX), which is exports minus imports. Mathematically, this is expressed as:

AD = C + I + G + (EX - IM)

Given the consumption function C = 1000 + 0.8YD, where YD is disposable income, YD = Y - T. Therefore, C becomes a function of Y:

C = 1000 + 0.8(Y - 300) = 1000 + 0.8Y - 240 = 760 + 0.8Y

The net exports, considering imports are proportional to Y, are:

NX = EX - IM = 400 - 0.05Y

Plugging these into the aggregate demand formula:

AD = (760 + 0.8Y) + 500 + 400 + (400 - 0.05Y) = 760 + 0.8Y + 500 + 400 + 400 - 0.05Y

Simplifying,

AD = (760 + 500 + 400 + 400) + (0.8Y - 0.05Y) = 2060 + 0.75Y

At equilibrium, AD = Y, so:

Y = 2060 + 0.75Y

Rearranging to solve for Y:

Y - 0.75Y = 2060

0.25Y = 2060

Y = 2060 / 0.25 = 8240

Thus, the equilibrium output (Y) in this open economy is approximately 8,240 units.

Marginal Propensity to Save and Import

The marginal propensity to save (MPS) is the portion of additional income that is saved rather than consumed. Since the marginal propensity to consume (MPC) is 0.8, the MPS is:

MPS = 1 - MPC = 1 - 0.8 = 0.2

The marginal propensity to import (MPM), given directly as IM = 0.05Y, is 0.05, indicating that for each additional unit of income, 5% is spent on imports.

Fiscal Multipliers: Tax and Spending

The tax multiplier measures the change in output resulting from a change in taxes, whereas the spending multiplier measures the change due to a change in government spending.

The spending multiplier (kG) in an open economy is derived as:

kG = 1 / (1 - MPC + MPM) = 1 / (1 - 0.8 + 0.05) = 1 / (0.25 + 0.05) = 1 / 0.30 ≈ 3.33

The tax multiplier (kT) is:

kT = - MPC / (1 - MPC + MPM) = - 0.8 / 0.30 ≈ -2.67

This indicates that a one-unit increase in government spending increases output by roughly 3.33 units, while a one-unit increase in taxes decreases output by approximately 2.67 units.

Balanced Budget Multiplier

The balanced budget multiplier is the effect of simultaneous equal changes in spending and taxes. Algebraically, since the change in output (ΔY) is:

ΔY = kG ΔG + kT ΔT

And for a balanced budget change, ΔG = - ΔT, the overall change becomes:

ΔY = kG ΔG + kT (- ΔG) = (kG - kT) * ΔG

Plugging in the values:

(3.33 - (-2.67)) ΔG = (3.33 + 2.67) ΔG = 6.00 * ΔG

Therefore, the balanced budget multiplier is approximately 6, which is different from the simple one-unit multiplier in a closed economy. This suggests that in an open economy with these parameters, the effect of a balanced increase in government spending and taxes is magnified, mainly because of the open trade components and the multipliers at play.

Policy Impact: Increase in Government Spending by 200

With an increase in G by 200, the change in equilibrium output is:

ΔY = kG ΔG = 3.33 200 ≈ 666

Adding this to the initial equilibrium output:

New Y = 8240 + 666 ≈ 8906

Thus, the new equilibrium output rises to approximately 8,906 units, reflecting the stimulative effect of increased government expenditure.

Impact of Decreased Investment and Reduced Taxes

Suppose investment decreases by 100 and taxes are cut by 150. The total change in aggregate demand results from these two policy shifts:

Change in G: ΔG = -100 (assuming no change in G for simplicity, as the problem states only investment and taxes vary)

Change in taxes: ΔT = -150

The change in output due to investment change is:

ΔY_investment = kG ΔI = 3.33 (-100) = -333

The change due to tax cut is:

ΔY_taxes = kT ΔT = - 2.67 (-150) = + 400.5

Summing these effects yields:

ΔY_total = -333 + 400.5 = approximately +67.5

Adding this to the original equilibrium output:

Y_new = 8240 + 67.5 ≈ 8307.5

This indicates that even with a reduction in investment, the tax cut's expansionary effect modestly increases the overall output in the economy.

Conclusion

The analysis of this open economy underscores the significant role of fiscal policy and international trade in shaping macroeconomic outcomes. The derived equilibrium output provides a benchmark for policy interventions, illustrating the multipliers’ magnified effects when considering open trade components. Understanding these relationships facilitates better policymaking aimed at stabilizing and stimulating economic growth within such an interconnected context.

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