UNIVERSITY OF MANAGEMENT AND TECHNOLOGY
ASSIGNMENT - 5
SUBMITTED TO: MS. AFIA MUSHTAQ
Bilal Ahmad 12002001006
Sajid Nadeem 12002001004
M. Aqeel Butt 12002001009
Basir Khan 12002001010
M A C R O - E C O N O M I C S
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Q: 1 briefly explains the following with examples.
Investment expenditures that the business sector intends to undertake based on expected
economic conditions, interest rates, sales, and profitability.
The difference between planned and actual investment is unplanned investment, which is
inventory changes caused by a difference between aggregate expenditures and aggregate output.
If actual and planned investments differ, then aggregate expenditures are not equal to aggregate
output, and the macro economy is not in equilibrium.1
They are the federal governments or receipts that automatically increase without any action by
the government. They work as a tool to dampen fluctuations in real GDP for example taxes,
transfers, and purchases are automatic stabilizers of the economy.2
This not only provides support for struggling citizens, but also gets money to people very likely
to spend it, which boosts demand as the economy weakens.
When incomes are high, tax liabilities rise and eligibility for government benefits falls, without
any change in the tax code or other legislation. Conversely, when incomes slip, tax liabilities
drop and more families become eligible for government transfer programs, such as food stamps
and unemployment insurance that help support their income.3
Automatic stabilizers are so called
because they act to stabilize economic cycles and are automatically triggered without explicit
In a progressive taxation structure, the share of taxes in national income falls when the economy
is booming and rises when the economy is in a slump. This has the effect of cushioning the
economy from changes in the business cycle.
Crowding out effect
A situation when increased interest rates lead to a reduction in private investment spending such
that it dampens the initial increase of total investment spending is called crowding out effect.
For Example: crowding out occurs is government financing of projects with deficit spending
through the use of borrowed money. Because the government borrows such large amounts of
capital, its activities can increase interest rates. Higher interest rates discourage individuals and
businesses from borrowing money, which reduces their spending and investment activities.
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Aggregate expenditures are the total expenditures on gross domestic product. These expenditures
are used by the household, business, government, and foreign sectors to purchase the entire gross
domestic product supplied by the domestic economy. These combined expenditures are a key
part of the foundation of macroeconomic analysis or unemployment, inflation, business cycles,
and other phenomena.4
The equation is:
AE = C + I + G + NX
Q 2: Consider a closed economy to which the Keynesian-cross analysis
applies. Consumption is given by the equation C = 100 + 2/3(Y – T),
where Y represents income and T represents taxes. Planned investment
is 300, as are government spending and taxes.
According to the statement above;
C = 100 + 2/3(Y – T)
Planned investment = I = 300
Govt. spending = G = 300
Taxes = T = 300
A. If Y is 1,500, what are planned aggregate expenditures? What is inventory
accumulation orde-accumulation? Should equilibrium Y be higher or lower
Hint; planned expenditure=Y, and inventory =Y-planned expenditure
If Y is 1500 then
Planned Aggregate Expenditure = E = C+I+G
= 100+ 0.66667(Y-T)+300+300
= 700 + 0.66667(1500-300)
So when Y=1500, Planned Aggregate Expenditure is 1500.
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Y=1500, and Planned Aggregate Expenditure is also 1500 i.e. both are equal (Y – Planned
expenditure = 1500 - 1500 = 0) which is an ideal situation because if aggregate output (income)
(Y) is not equal to planned aggregate expenditure, firms will react until equilibrium is achieved.
1. When planned aggregate expenditure exceeds aggregate output (income), unplanned inventory
reductions occur, and firms react by increasing output.
2. When planned aggregate expenditure is less than aggregate output (income), unplanned
inventory increases occur, and firms react by decreasing output.
As Y=1500 and planned aggregate expenditure is also 1500, so we do not need to change the
B. What is the planned expenditure function? What is equilibrium level of
income? Show your results in a diagram clearly indicating the intercepts and
The planned expenditure function, E = C+I+G
=100 +2/3(Y-T) +300+300
= 700 + 2/3(Y-300)
= 700 +2/3Y -200
= 500 + 2/3Y
So, the planned expenditure function is 500+2/3Y i.e. E = 500+2/3Y
If Y is 0, E = 500. So, the vertical intercept (E-intercept) of the expenditure function is
The equilibrium condition: Y = E
Or, Y = 500 +2/3Y
Or, Y-2/3Y = 500
Or, Y (1-2/3) Y = 500
Or, 1/3Y = 500
Or, Y = 1500
So, equilibrium level of income is 1500.
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C. What are equilibrium consumption, private saving, public saving, and
Hint: private saving=Y-C-T
The equilibrium consumption, C= 100 + 2/3(Y-T)
= 100 + 2/3 (1500-300)
= 100 + 2/3(1200)
So, the equilibrium consumption is 900.
The equilibrium private saving, SP = Y-C-T
So, the equilibrium private saving is 300.
The equilibrium public saving, SG = T-G
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So, the equilibrium public saving is 0.
The equilibrium national saving, S= Y-C-T
So, the equilibrium national saving is 300.
d. How much does equilibrium income decrease when G is reduced to 200?
What is the multiplier for government spending?
Y = C + I + G
Where C = 900
Y = 900 + 300 + 200
As C = 100 + 2/3(Y-T)
So MPC = 2/3 =0.66667
The government spending multiplier = 1/(1-MPC)