Question

In the Keynesian cross model, assume that the consumption function is given by C=120+0.8(Y−T).

Planned investment is 200; government purchases and taxes are both 400. Y, C, I G&T are all in billions.

1. Graph planned expenditure as a function of income.
2. What is equilibrium income?
3. If government purchases increase to 420, what is the new equilibrium income? What is the multiplier for government purchases?
4. What level of government purchases is needed to achieve an income of 2,400? (Taxes remain at 400.)
5. What level of taxes is needed to achieve an income of 2,400? (Government purchases remain at 400.)
6. If you were the economic adviser to the president and the government’s goal is to stimulate the economy by increasing GDP by $2,400 billion, which one will you recommend to achieved this GDP target? Government spending or tax cut? Why?

Answer 1