Question

An economy is described by the following equations:

C	= 1,500 + 0.9 (Y – T)
I p	= 1000
G	= 1,500
NX	= 100
T	= 1,500
Y*	= 8,800

The multiplier for this economy is 10.

Find the effect on short-run equilibrium output of:

a. An increase in government purchases by 100 from 1,500 to 1,600.

Instruction: Enter your response as an integer value.

Short-run equilibrium output will increase to .

b. A decrease in tax collections from 1,500 to 1,400 (leaving government purchases at their original value of 1,500).

Instruction: Enter your response as an integer value.

Short-run equilibrium output will increase to

c. A decrease in planned investment spending by 100 from 1,000 to 900 (leaving government purchases and taxes unchanged at their original values of 1,500).

Instruction: Enter your response as an integer value.

Short-run equilibrium output will decrease to .

Answer 1

We see that current equilibrium occurs at AE = Y
1500+0.9*(Y-1500)+1000+1500+100 = Y
2750 = 0.1Y
Y* = AE* = 27500.
a. An increase in government purchases by 100 from 1,500 to 1,600 will increase the real GDP by
100*10 (multiplier) = $1000. New GDP is 28500.
Short-run equilibrium output will increase to 28500.
b. A decrease in tax collections from 1,500 to 1,400 will increase GDP by 900. This is because tax
multiplier is MPC/1-MPC = 0.9/0.1 = 0. Hence increase in GDP = 9*100 = 900
Short-run equilibrium output will increase to 28400
c. A decrease in planned investment spending by 100 from 1,000 to 900 will decrease GDP by 1000
because multiplier is 10 so decrease in GDP = 100*10 = 1000
Short-run equilibrium output will decrease to 26500.