Question

An economy has full-employment output of 5000. Government purchases are 1000. Desired consumption and desired investment are given by

Cd = 3000 - 2000r + 0.10Y
Id = 1000 - 4000r
where Y is output and r is the expected real interest rate. The real interest rate that clears the goods market is equal toA. 25.00%.B. 8.33%.C. 2.50%.D. 1.25%.

Answer 1

Answer:

Option (B) is correct.

Explanation:

Given that,

Full-employment output = 5,000

Government purchases = 1,000

Desired consumption: Cd = 3000 - 2,000r + 0.10Y

Desired investment: Id = 1000 - 4,000r

Y = Cd + Id + Gd

Y = (3000 - 2000r + 0.10Y) + (1,000 - 4,000r) + 1,000

Y - 0.10Y = 5,000 - 6,000r

0.90Y = 5,000 - 6,000r

At full employment output level of 5,000,

0.90(5,000) = 5,000 - 6,000r

4,500 = 5,000 - 6,000r

6,000r = 500

r = 0.0833 or 8.33%

Therefore, the real interest rate that clears the goods market is equal to 8.33%.