Suppose a newly elected president cuts taxes by 20 percent: i. Assuming that the money supply is held constant, what are the new equilibrium interest rate and income

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An economy is initially described by the following equations:

C = 80 + 0.8(Y – T)

I = 120 –5r

M/P = Y – 25r

G = 100

T = 100

M = 2,700

P = 3

answer :

equilibrium interest rate ( r ) = 5.6%

equilibrium level of income = 1040

Explanation:

a) New equilibrium interest rate

T = 100 - 20/100 ( 100 ) = 80

Y = C + I + G

   = 80 + 0.8( y - 80 ) + 120 - 5r + 100

   = 236 + 0.8y - 5r

y  = 1180 - 25r   ( 1 )

M/P = Y - 25r = 2700 / 3

y = 900 + 25r ( 2 )

equate;  equation ( 1 ) and equation ( 2 )

1180 - 25r = 900 + 25r

∴ r = 5.6%

b) Equilibrium level of Income

To determine Equilibrium level of income we will use equation2

Y = 900 + 25(5.6)  = 1040

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