Question

Given: C = 200+ .75(Yd), initial equilibrium = $6000, the target full-employment equilibrium = $9000.

a. Calculate the spending multiplier. Calculate the tax multiplier.

b. If G increases by $10, calculate the CHANGE in equilibrium. Y.

c. If T increases by $10, calculate the CHANGE in equilibrium Y.

d. If G increases by $10 AND T increases by $10, AT THE SAME TIME, calculate the change in equilibrium Y.

e. Starting from the initial equilibrium of $6000, by how much would G have to be increased to reach the target Y?

f. Starting from the initial equilibrium of $6000, by how much would T have to be decreased to reach the target Y?

Answer 1

a) C = 200+ .75(Yd), thus MPC = 0.75.

Spending multiplier= ∆Y/∆G= 1/(1-MPC) = 1/0.25 = 4

Tax multiplier=∆Y/∆T= -MPC/(1-MPC) = -0.75/0.25 = -3.

b. When G increases by $10 i.e ∆G=10, change in Y(∆Y) = 4*10 = 40, Y will increase by $40

c. If T increases by $10, the change in equilibrium Y will be -3*10 = -30, i.e Y will reduce by $30.

d. If G increases by $10 and T increases by $10, it means it is a balanced budget and value of balanced budget multiplier is 1 and hence change in Y is equal to 1*10 = 10, Y increases by $10.