Question

in the economy of coconut island, autonomous counsumption expenditure is $50 million, and the marginal propensity to consume is 0.8. Investment is $160 million, government expenditure is $190 million, and net taxes are $250 million. Investment, government purchases, and taxes are constant-they do not vary with income. The island does not trade with the rest of the world.

a) Draw the aggregate expenditure curve

b) What is the equilibrium real GDP for Coconut Island?

c) What is the size of the multiplier in Coconut Island's economy?

D) If the government increases its purchases by $200 million, what will be the change in the economy's equilibrium real GDP?

Answer 1

a) Below is the graph and table

Y	AE
0	200
200	360
400	520
600	680
800	840
1000	1000
1200	1160
1400	1320
1600	1480
1800	1640
2000	1800
2200	1960

b) We use AE = Y

C + I + G = Y

50+0.8*(Y - 250)+160+190 = Y

400 + 0.8Y - 200 = Y

200 = 0.2Y

Y = 1000 is the equilibrium real GDP for Coconut Island

c) 1/1-MPC = 1/1-0.8 = 5  is the size of the multiplier in Coconut Island's economy

d) We are given that ?Y/?G = multiplier or ?Y/?G = 5. This implies ?Y = ?G x 5 or ?Y = 200*5 = 1000

So If the government increases its purchases by $200 million, the change in the economy's equilibrium real GDP will be 1000.