Question 2

question 2.1

Give an example of a situation when an economy is in recession according to both definitions of recession and give another example of a situation when an economy may be in recession according to one of the definitions but not the other.

question 2.2

Consider two identical countries.  The only difference between them is that in country A the marginal propensity to consume (out of disposable income) MPC=0.4 and in country B MPC=0.7.  The marginal tax rate t=0.2.  I=20,000, G=10,000, NX=25,000-0.2Y (where Y is total income), c0=15,000.

a) Calculate the multiplier in both countries (round up to two decimal places)

b) (i)  What would be the equilibrium levels of output in country A and country B?

(ii) Show the equilibrium levels of output in country A and country B on awell labelled graph with aggregate demand on the vertical axis and output (income) on the horizontal axis.

c) Now assume that consumers lose their confidence and decrease autonomous consumption c0 from 15,000 to 10,000.   What will happen to output in both countries?  Which country will have a larger effect on its GDP?  Illustrate using the graph from part b). 

question 2.3

Usually investment depends on the interest rate. Briefly explain how an increase in the interest rate r would affect aggregate investment.  Use a reference to the expected rate of profit in your explanation.