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25 September, 07:05

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%.

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  1. 25 September, 10:20
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    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%.
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