Question

Tattooine is a developing country situated in a remote region of Eastern Europe. It is the largest producer of marsh gas in the world and is heavily dependent on its exports of gas to the rest of the world. Very much a state run-economy with high welfare benefits, it imports much of what it requires for its economy, lacking in natural resources, Its main growth indicators in 2013 are made up of autonomous consumption $30, investment $10, government expenditure $30, exports $70, imports $60 and transfer payments are $20 (All information is expressed in billions of dollars). The marginal propensity to consume is 0.6. The income tax rate is 0.30 and import rate is 0.1. Assume Tattooine is a two-sector closed economy Provide detailed workings and attempt all questions by determining/calculating: [limit your answer to two decimal points]:

a) Aggregate expenditure function

b) The autonomous expenditure multiplier

Answer 1

(a)

Yd = Y - T + TR = Y - tY + TR = Y - 0.3Y + 20 = 0.7Y + 20

C = C0 + mpc x Yd = 30 + 0.6 x (0.7Y + 20) = 30 + 0.42Y + 12 = 42 + 0.42Y

I = 10

G = 30

X = 70

M = mpm x Y = 0.1Y

Aggregate expenditure (AE) = C + I + G + X - M

AE = 42 + 0.42Y + 10 + 30 + 70 - 0.1Y

AE = 152 + 0.32Y

(b)

Multiplier = 1 / [1 - mpc(1 - t) + mpm]

Multiplier = 1 / [1 - 0.6 x (1 - 0.3) + 0.1]

Multiplier = 1 / [1 - (0.6 x 0.7) + 0.1]

Multiplier = 1 / (1.1 - 0.42)

Multiplier = 1 / 0.68

Multiplier = 1.47