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(Advanced analysis) In a private closed economy (a) the marginal propensity to save is 0.25, (b)...

(Advanced analysis) In a private closed economy (a) the marginal propensity to save is 0.25, (b) consumption equals income at $120 billion, and (c) the level of investment is $40 billion. What is the equilibrium level of income? I know the answer is 280 billion but how do I get there?

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Answer #1

In a closed economy consumption = $120 billion.

Investment = 40 billion. Any investment will increase by the amount of multiplier in the nation. The multiplier = 1/MPS

MPS= 0.25. The multiplier = 1/0.25 = 4.

AN increase in the investment will lead to an increase in the total output by 4 times. An investment of 40 billion will lead to an increase of 160 billion.

Total output at equilibrium = Consumption + Investment (multiplier)

= $120 + $160

= $280 billion.  

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