Keyenesian Model Practice

Keynesian Model Practice
Here are some practice problems using the Keynesian model. Note that C̄ is autonomous consumption and
c is the marginal propensity to consume. Tax rate is t so that total taxes are tY . The marginal propensity
to import is m and transfers are Tr .
1. Let I = 20, C̄ = 10 and the c = 0.8. Compute Y and C. Solution: Solve Y = C + I and C = C̄ + cY
simultaneously (isolate and substitute) to obtain Y = 150, C = 130.
2. Let I = 100, C̄ = 34 and the c = 0.75 (marginal propensity to consume). Compute Y and C. Solution:
Y = 536, C = 436.
3. In the previous problem calculate household savings. Solution: S = Y − C = 536 − 436 = 100, or from
S = I, S = 100.
4. Let I = 150, C̄ = 34 and the c = 0.75 (marginal propensity to consume). Compute Y and C. Solution:
Y = 736, C = 586.
5. In the previous problem compute income using the multiplier. Solution: Y = µ∆I, where µ =
1/(1 − c) = 4 so the change in Y is the multiplier times the change in I. ∆Y = 4(50) = 200. The new
level of Y = 536 + 200 = 736.
6. In the previous problem, if consumption increases to 600, while production remains at 736, compute
the change in inventories. Solution: Y = 736 − 600 − 150 = −14. Inventories fall by 14. This will
cause output to rise in the next period.
7. For the SAM given in table 1, let the mpc = 0.67. Compute C̄ to calibrate the consumption function
to the SAM. Solution: Household income is 50 with consumption at 40.5. Autonomous consumption
is then C̄ = 40.5 − 0.67(50) = 7.
8. Using the C̄ = 7 from the previous problem, show that the solution for the Keynesian model is given
in the SAM. Solution: Solve the system
Y =C +I
Y = C̄ + cY
simultaneously for Y, C. This should give
Y = C + 9.5
C = 7 + 0.67Y
or, substituting the second equation into the first Y = 7 + 0.67Y + 9.5 or Y = 50. Thus, C =
7 + 0.67(50) = 40.5. Savings is Y − C = 50 − 40.5 = 9.5
9. Let I = 20, C̄ = 10, G = 15 with c = 0.8 and the tax rate t = 0.2 Compute Y and C and government
savings, Sg , (the negative of the deficit). Solution: Y = 125, C = 90, Sg = 10.
10. Let I = 20, C̄ = 10. G = 25 and c = 0.8 and the tax rate t = 0.2 Compute Y and C and the new
government savings. Solution: Y = 152.8, C = 107.8, Sg = 5.6.
11. In the previous problem government spending went up by 10. Compute the change in GDP using
the multiplier 1/[1 − (1 + t)c]. Note that the multiplier is different with taxes in the model. Solution:
µ = 2.78, so ∆Y = 2.778(25 − 15) = 27.8. The new level of Y = 138.9 + 27.8 = 152.8, the same as
calculated directly.
Table 1: A Social Accounting Matrix
Firms Household Invest Total

Firms 40.5 9.5 50
HH 40.5 40.5
Savings 9.5 9.5
Total 50 50 9.5
Source: made-up numbers.
Firms Household Invest Govt Net Exports Total

Firms 99.6 20 25 −4.6 140
HHolds 140 140
Savings 12.4 3 4.6 20
Govt 28 28
Foreign 0
Total 140 140 20 28 0
12. The level of government spending went up by 10, but government savings fell by only 4.4. Why is this?
Solution: Think about what has happened to total tax revenues.
13. Let imports be mY with the marginal propensity to import m = 0.14. Exports are E = 12, I =
20, C̄ = 10. G = 25 and c = 0.8 and the tax rate t = 0.2. Compute Y and C, Sg and foreign savings
(the current account deficit), S ∗ . Solution: Y = 134, C = 95.8, Sg = 1.8, S ∗ = 6.8.
14. In the previous problem raise exports to 15. Compute Y and C and the new government savings and
foreign savings. Solution: Y = 140, C = 99.6, Sg = 3, S ∗ = 4.6.
15. In the previous problem exports went up by 3. Compute the change in GDP using the multiplier
µ = 1/[1 − (1 + t)c + m]. Note that the multiplier is different with taxes and imports in the model.
Solution: µ = 2, so ∆Y = 2(3) = 6. The new level of Y = 134 + 6 = 140, the same as calculated
directly. Note that you can also use the multiplier to calculate the change in consumption, government
savings and the level of foreign savings.
16. Write out a new SAM for the previous problem. Solution: The SAM is table 2.
17. In the SAM of table 3, let the marginal propensity to consume be 0.7 and the marginal propensity to
import be 0.1. Note that transfers to households are 80. Compute the level of Y, C, Sg , S ∗ and show
that they agree with the SAM.
Solution: We must figure out the tax rate, which is 180/1200 =0.15. Net exports are -30 so this
must mean N x = E − mY or E − 0.1(1120) = −30 so that E = 82. Disposable income is Yd =
(1 − t)(Y + Tr ) = (1 − 0.15)(1200) = 1020. Thus C̄ = C − cYd = 800 − 0.7(1020) = 86. To solve this
model, write
Y = C + I + G + E − mY
C = C̄ + (1 − t)(Y + Tr )
2
Firms Household Invest Govt Net Exports Total

Firms 800 200 150 -30 1120
HHolds 1120 80 1200
Savings 220 -50 30 200
Govt 180 180
Foreign 0
Total 1120 1200 200 180 0
Substituting the second equation into the first and then putting in the data from the SAM.
Y = 86 + 0.7(1 − .15)(Y + 80) + 200 + 150 + 82 − 0.1Y

0.505Y = 86 + 47.6 + 432
Y = 1120
C = 86 + 0.7(1 − 0.15)(1200) = 800
18. Now calibrate the Solow model to this SAM. The capital output ratio is 3 and β = 0.4. Let A = 1.
Compute the capacity utilization ratio. Solution: The capital stock is 3(1120) = 3360. The share of
labor is 0.6 so that labor is 0.6(1120) = 672. The capital-labor ratio, k = 3360/672 = 5. Per worker
income is then y = Ak β =50.4 = 1.9, but the actual per worker income of the SAM is 1120/672 = 1.67.
Thus u = [1.67(672)]/[1.9(672)](1.67/1.9) = 0.875.
19. Now increase transfers by 10 and recalculate the new levels of Y, C, Sg and S ∗ . Solution: Y =
1131.8, C = 813, Sg = −56.7, S ∗ = 31.2.
20. In the last question, what happens to capacity utilization? Solution: Capacity remains the same but
demand has increased. Income per worker rises to 1131.8/672 =1.68/1.9=0.885.

Keyenesian Model Practice

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Keynesian Model Practice

simultaneously for Y, C. This should give

Firms Household Invest Total

Source: made-up numbers.

Table 2: A Social Accounting Matrix

Firms Household Invest Govt Net Exports Total

Source: made-up numbers.

Firms Household Invest Govt Net Exports Total

Source: made-up numbers.

Y = 86 + 0.7(1 − .15)(Y + 80) + 200 + 150 + 82 − 0.1Y

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