Question 12.10.2: Consider the alternative macroeconomic model (i) Y = C + I +......
Consider the alternative macroeconomic model
(i) Y = C + I + G (ii) C = f (Y − T) (iii) G =\overline{G}
whose variables have the same interpretations as in the previous example. Here the level of public expenditure is a constant, \overline{G}. Determine the number of degrees of freedom in the model.
There are now three equations in the five variables Y, C, I, G, and T. Hence, there are two degrees of freedom. For suitable functions f , two of the variables can be freely chosen, while allowing the remaining variables to be determined once the values of these two are fixed. It is natural to consider I and T as the two free variables. Note that G cannot be chosen as a free variable in this case because it is fixed by equation (iii).