MACROSIM1 HOMEWORK

The MacroSim1 homework is done by using Version 2 of the Macrosim.exe model, which has been provided to you (typically through instructions to download it from the internet). Begin this homework by starting that model. You will see a screen with three model selections, MacroSim1, which will be used for this assignment, MacroSim2, and BudSim. Begin by selecting the “View Model” option for MacroSim1. This will show the equation set used in MacroSim1, which is explained in detail in a document entitled “Introduction to the MacroSim1 and MacroSim2 Simulation Models.” After looking at the model, click the “OK” button and return to the main menu.

Select MacroSim1 and a spreadsheet with default assumptions will appear. When using the model, keep three operating rules in mind:

1. When overriding default values to make your simulations, you need to change only the cells that you are overriding. You do not need to retype all of the default values.

2. When making data entry, the entry is not registered until you have hit either the <Enter> key or an arrow key.

3. Run the simulation by using the calculate key.

4. If you are asked, after a trial, to exit the model using the appropriate key, do that and restart the model. Certain values accumulate in this model and this has the effect of restoring default (this could have been done with a “Restore Defaults” key but we didn’t put one in).

Although it is not required, you may want to print out the trials below to refer to them later. To print a simulation, select <File> then “Print.”

The purpose of the first two trials is to see if the multiplier works as expected. Start MacroSim1 and look at the value of the multiplier at the bottom of the screen (2.50). The origin and meaning of this multiplier was explained in “Introduction to the MacroSim1 and MacroSim2 Simulation Models.” You might want to review that before beginning this trial.

Trial 1:

Leaving all other values at default values, increase government spending from 40 to 42, then calculate the simulation.

1. What is the new level of GDP?

2. By how much did GDP increase?

3. Did the multiplier work as predicted?

4. By how much did the budget deficit rise?

5. Given that government spending rose by 2 and the deficit rose by far less than this, how do you explain this (think about the answer ... don’t dismiss it).

Trial 2:

Now exit the model and restart MacroSim1. This time raise Investment from its default value of 14 to 16 and calculate the simulation.

1. What is the new level of GDP?

2. Did the multiplier work as expected?

3. What happened to the budget deficit (when the deficit shows a negative number, that is a surplus)?

4. Why did the budget deficit go to a surplus (the answer is found in model equation 4)?

Clearly, in MacroSim1, any increase in the two autonomous categories of spending have a strong stimulating effect upon the economy, via the multiplier. The two categories, however, have an opposite effect upon the budget deficit. But what do we care? The impact upon GDP and Consumption is the same. Does this make you suspicious about the integrity of the model (it should)?

The next three trials experiment with tax rate changes.

Trial 3:

Exit and restart the model and lower the Tax Rate from the default value of .25 to .22.

1. What effect did this have upon GDP?

2. What effect did this have upon the budget deficit?

3. Why did the budget deficit behave this way?

4. What effect did this have upon the multiplier, and why?

Trial 5:

Clear the model and experiment with various increases and decreases in the Tax Rate.

1. In the context of this model, what generalizations can we make about the impact of changes in the tax rate upon the economy? Upon the deficit?

Trial 6:

Now let’s do what the government often does. Increase government spending slightly and lower taxes slightly (experiment with different values).

1. What effect does this seem to have upon GDP and Consumption? Is the “standard of living” rising in the model? Might this be politically popular in a real economy?

2. What happens to the Budget Deficit when you pursue this policy?

MacroSim1 seems to imply that we need not be worried about budget deficits. When they loom up in the simulation, it is usually under circumstances where the economy is growing greatly. Let’s pursue this a little more.

Trial 7:

Clear the model, and in the TRIAL 1 column make some assumption that produces a budget deficit in the simulation. After this simulation, though, don’t clear the model. Use the next two columns to bring the budget back into balance or into a small surplus. Experiment with this.

1. In this model, what seems to be the economic effect of any effort to bring a budget deficit back into balance or into a surplus, no matter how you do it?

2. What seem to be the policy implications of trials 3 through 7 above? What would this model advise as “good policy” if our goal is to stimulate GDP and raise consumption?

There is one odd thing about this model. Because of this model’s mathematical structure, in every simulation where you increased the budget deficit, the amount of savings increased by exactly the same amount as the deficit! This can easily be seen if you printed your simulations. Given that budget deficits by definition must be borrowed, this seems to imply the budget deficits are self-financing! We’ll return to this in MacroSim2.

The remaining trials explore the impact of changing the consumption and savings rates. Because savings is what is left over after consumption from disposable income (see equations 2 and 5a), when the consumption rate is raised, the savings rate falls.

Trial 8:

Clear the model and raise the consumption rate from .80 to .85 and run the simulation. Then experiment with higher and lower consumption rate levels

1. What effect does (from .80 to .85) this have upon the multiplier, and why?

2. What effect does this have upon GDP?

3. What does this result seem to imply about the impact of attitudes about consumption and savings in an economy? If you want high economic growth, what kind of ideal consumers do you want to have?