DSE 2013 Question 53: Keynesian cross and the multiplier
Consider an open economy simple Keynesian model with autonomous investment I. People save a constant proportion s of disposable income and consume the rest. Government taxes total income at a constant rate τ and spends an exogenous amount G. Exports X are autonomous at the fixed real exchange rate (normalized to unity). Imports M are a linear function of total income with constant import propensity m. Let I=3200, G=4000, X=800, s=21, τ=52, and m=101.
Now suppose the government decides to maintain balanced trade by appropriately adjusting the tax rate τ (thereby affecting domestic absorption), without changing the exchange rate or G, with other parameters unchanged. The government:
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Consider an open economy simple Keynesian model with autonomous investment I. People save a constant proportion s of disposable income and consume the rest. Government taxes total income at a constant rate τ and spends an exogenous amount G. Exports X are autonomous at the fixed real exchange rate (normalized to unity). Imports M are a linear function of total income with constant import propensity m. Let I=3200, G=4000, X=800, s=1/2, τ=2/5, and m=1/10. Now suppose the government decides to maintain balanced trade by appropriately adjusting the tax rate τ (thereby affecting domestic absorption), without changing the exchange rate or G, with other parameters unchanged. The government: (A) can attain this by decreasing the tax rate to 1/5 (B) can attain this by increasing the tax rate to 4/5 (C) can attain this by simply keeping the tax rate unchanged at 2/5 (D) can never attain this objective by adjusting only the tax rate
Also written as: Consider an open economy simple Keynesian model with autonomous investment I. People save a constant proportion s of disposable income and consume the rest. Government taxes total income at a constant rate tau and spends an exogenous amount G. Exports X are autonomous at the fixed real exchange rate (normalized to unity). Imports M are a linear function of total income with constant import propensity m. Let I=3200, G=4000, X=800, s=1/2, tau=2/5, and m=1/10. Now suppose the government decides to maintain balanced trade by appropriately adjusting the tax rate tau (thereby affecting domestic absorption), without changing the exchange rate or G, with other parameters unchanged. The government:
Keynesian cross and the multiplier has come up 167 times in 7 exams since 2006.
What this question tests
This question is on The open-economy multiplier, part of Keynesian cross and the multiplier in Macroeconomics.
How imports leak spending abroad and shrink the multiplier.
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