Question

1. Suppose the United States economy is represented by the following equations: Z= C + I + G , C = 500 + 0.5Yd, Yd = Y − T T = 600, I = 300, G = 2000, Where, Z is demand for goods and services, Yd is disposable income, T is taxes, I is investment and G is government spending. Y is income/production. (a) Assume that the economy is in equilibrium. What does it mean in terms of the relationship between income/production (Y) and demand (Z)? (b) Given the above variables, calculate the equilibrium level of output. (c) Now, assume that government spending decreases from 2000 to 1600. What is the new equilibrium level of output? How much does income change as a result of this event? (d) What is the multiplier for this economy?

2. Graphically illustrate the effects of an increase in autonomous consumption (c0) on the demand line (ZZ) and Y. Indicate the initial and final equilibrium level of output in your graph. Why this increase is greater than the initial change in autonomous consumption?

3. Suppose the consumption in an economy is represented by the following equation: C = 250 + 0.75.Yd (a) Calculate the multiplier in this economy? What is the interpretation of multiplier? (b) Calculate the propensity to save. (c) If the government in this economy increases government spending by 100, what is the effect on the total output?

Answer 1

(1)

(a)

In equilibrium, planned aggregate demand (AE) is equal to total income/production (Z), so there is zero unplanned inventory. Firms can sell all their output produced without using existing inventory.,

(b)

In equilibrium, Z = Y = C + I + G

Y = 500 + 0.5(Y - 600) + 300 + 2000

Y = 2800 + 0.5Y - 300

0.5Y = 2500

Y = 5000

(c)

When G = 1600,

Y = 500 + 0.5(Y - 600) + 300 + 1600

Y = 2400 + 0.5Y - 300

0.5Y = 2100

Y = 4200

Change in income = 4200 - 5000 = -800 (decrease)

(d)

Multiplier = Change in Y / Change in G = (4200 - 5000) / (1600 - 2000) = -800 / -400 = 2

NOTE: As per Answering Policy, 1st question is answered.