Question

I just need the analysis for the second part why when I have a decrease in net export the answer is not 500X5. I just need good explaining for the analysis. 500X5= 2500 however it didn't decrease by 2500 when I plugged number into the equation, but when I do that when government expenditure increase it works? why?

Consumption spending in a country is represented by C = 1800+ 0.8(Y-T ). Planned investment is 900, government purchases G = 0, net exports NX = 100 and T = 0.2Y.

1. Write down planned aggregate spending of the economy as a function of Y. Zero points if you do not show your work.

2. An important trading partner of the country goes through a major recession, decreasing the country’s net exports by $500. Use the Keynesian AE model to analyze the total impact of this shock on short-run equilibrium output, clearly explaining the multiplier effect. (5)

Answer 1

(Part II)

When NX = 100, in equilibrium: Y = C + I + G + NX

Y = 1800 + 0.8(Y - 0.2Y) + 900 + 0 + 100

Y = 2800 + 0.8 x 0.8Y

Y = 2800 + 0.64Y

0.36Y = 2800

Y = 7,777.78

When NX decreases by 500, new NX = 100 - 500 = - 400, so in equilibrium: Y = C + I + G + NX

Y = 1800 + 0.8(Y - 0.2Y) + 900 + 0 - 400

Y = 2300 + 0.8 x 0.8Y

Y = 2300 + 0.64Y

0.36Y = 2300

Y = 6,388.89

Decrease in Y = 7,777.78 - 6,388.89 = 1,388.89

Multiplier = Decrease in Y / Decrease in NX = 1,388.89 / 500 = 2.78

Here, MPC (c) = 0.8 and t = 0.2, so

Multiplier = 1 / [1 - c(1 - t)] = 1 / [1 - 0.8 x (1 - 0.2)] = 1 / [1 - (0.8 x 0.8)] = 1 / (1 - 0.64) = 1 / 0.36 = 2.78

In the graph, initial equilibrium is at point A where initial aggregate expenditure curve PAE0 intersects 450 line with initial output Y0 and aggregate expenditure E0. When net exports decrease, so planned aggregate expenditure (PAE) decreases, shifting the PAE line downward, decreasing both equilibrium aggregate demand and output.

In the graph, a decrease in net export from X0 to X1 shifts the PAE line downward from PAE0 to PAE1, decreasing equilibrium output from Y0 to Y1 and decreasing equilibrium aggregate expenditure to E1.

Here, downward shift in PAE = 100 (= decrease in NX) and (Y0 - Y1) = 1,338.89