In Macroland,the components of planned aggregate expenditure are given by:
C = 100 + 0.9(Y - T)- 500r
I = 150 - 1,000r
G = 200
NX = 50
If potential output equals 3,200,net taxes equal 100,and the central bank sets the interest rate to equal 0.05 (5%),then the bank must _____ the interest rate to ______ to restore full employment.
A) raise;6%
B) raise;7%
C) lower;4%
D) lower;3%
E) lower;2%

Question

Quizplus · Accepted Answer

The correct answer is A.The planned aggregate expenditure (AE) is given by:AE = C + I + G + NX= 100 + 0.9(Y - T) - 500r + 150 - 1,000r + 200 + 50= 500 + 0.9(Y - 100) - 1,500rAt full employment, Y = 3,200. Substituting this into the AE equation, we get:AE = 500 + 0.9(3,200 - 100) - 1,500(0.05)= 500 + 2,700 - 75= 3,125Since AE is less than potential output (3,200), the economy is in a recessionary gap. To restore full employment, the central bank must raise the interest rate to reduce aggregate expenditure.

In Macroland,the Components of Planned Aggregate Expenditure Are Given By