Question

Consider the following Keynesian-cross model of an economy:

Consider the following Keynesian-cross model of an economy:

C = 170 + 0.6 ( Y − T )

I = 250

G = 300

T = 200

By how much would government purchases have to increase in order to increase the equilibrium level of income by 50?

By how much would government purchases have to increase in order to increase the equilibrium level of income by 50?

Answer 1

The consumption function is as follows -

C = 170 + 0.6(Y-T)

Y - T denotes disposable income.

The coefficient of disposable income is MPC.

The MPC is 0.6

Calculate the multiplier -

Multiplier = 1/1-MPC = 1/1-0.6 = 1/0.4 = 2.5

The multiplier is 2.5.

Desired increase in the equilibrium level of income = 50

Calculate the increase in government purchases -

Increase in government purchases = Desired increase in the equilibrium level of income/Multiplier

Increase in government purchases = 50/2.5 = 20

Thus,

The government purchases would have to be increased by 20.