Applications of the The Goods Market Model

1. Suppose your economy is characterized by the following equations:
C = 1000 + .5(Y − T)
I = 2500 + .25Y
G = 0
T = 0
Note: for simplication, we have assumed G = T = 0
(a) Equilibrium:
i. Derive equilibrium output using under the equilibrium condition:
Y = C + I + G
ii. Derive equilibrium output under the equilibrium condition: I =
S + (T − G)
iii. What is equilibrium I and S ?
(b) Draw a diagram with the following elements:
i. I and S (measured in dollars) on the vertical axis
ii. Y (measured in dollars) on the horizontal axis
iii. Plots the I and S functions, with their intersection determining
equilibrium Y, I and S.
iv. Clearly label the slope of the I and S functions, as well as the
equilibrium values of I, S and Y
(c) Suppose people decide they want to save more, and so c0 reduces
from 1000 to 750
i. Draw this in the diagram
ii. What are the new values of I,S and Y? How do they compare with
the previous values (i.e. are they larger, smaller, or unchanged)?
iii. Suppose now that people choose to invest more, so that b0 increases from 2500 to 3000 (c0 remains at 750). What happens to
equilibrium I, S, and Y?
iv. What is the economic intuition behind your results?

SAMPLE ASSIGNMENT

Sample-2