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The following data give a complete picture of the household, business, and government sectors for 2001 in the small nation of Sylvania. (All dollar figures are in billions.)Consumption spending$50Capital stock (end of 2000)$100Capital stock (end of 2001)$103Government welfare payments$5Government unemploymentinsurance payments$2Government payroll$3Government outlays forequipment and material$2Depreciation rate7%Interest rate6%a. Assuming the government budget for 2001 was in balance, calculate total investment, government purchases, real GDP, total saving, and net taxes for this economy.b. Calculate total leakages and total injections.c. Now suppose, instead, that the government increased its spending by $2 billion for the year with no change in taxes. Explain how the variables from (a) will be affected (i.e., will they increase or decrease?).d. Draw a graph depicting the situation in the loanable funds market and reflecting the assumption of a balanced budget. Clearly label the equilibrium interest rate, saving, and demand for funds. Now, add another curve reflecting any change that occurs when the government runs a deficit; show what happens to the variables you discussed in (c).e. Under the assumption in (c), suppose Sylvania has a usury law that prohibits interest rates from going above 6 percent. Explain what will happen now in the loanable funds market, and in the economy as a whole.
Total investment Total Investment = change in the capital stock + depreciation = ($103 $100) +(0.07 $100) = $10 billion Government purchases Government purchases= Government payroll + Government outlays for materials= $3 + $2 = $5 billion Real GDP Real GDP=C+I+G= $50 + $10 + $5 = $65 billion Net taxes Net Taxes=Government purchases= $5 billion Total saving Total saving= Investment + Deficit = $10 + $0 = $10 billion Total leakages Total leakages=S+T= $10 + $5 = $15…

billion Total injections Total injections=I+G= $10 + $5 = $15 billion If the government ran a deficit, the interest rate would rise. This would cause total investment spending to decrease, and saving to rise. All of the other variables net taxes, real GDP, total leakages and injections would be unaffected.



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