Question

Suppose that the economy is characterized by the consumption function C=151+ 0.1(Y-T) with exogenous investment I = 10, government purchases G = 20, and taxes T = 10. Which of the following is true?

the multiplier is 0.9

the equilibrium consumption/output ratio is C/Y = 0.9

the autonomous spending is 170.

equilibrium output is Y = 200

the government budget is balanced

Answer 1

At equilibrium, C + I + G = Y

C = 151 + 0.1(Y - T) where MPC = 0.1

a) Multiplier = [1 / (1 - MPC)] = [1 / (1 - 0.1)] = 1.11. Option A is incorrect.

b) At Equilibrium, C = 151 + 0.1 (200 - 10) = 160

Thus, C / Y = 160 / 200 = 0.8 which makes option B incorrect.

c) Autonomous spending is 151 which is part of consumption function which makes option C incorrect.

d) 151 + 0.1 (Y - 10) + 10 + 20 = Y

151 + 0.1Y - 1 + 10 + 20 = Y

180 = 0.9Y

Y = 200

Option D is correct.

e) Government budget is not balanced because spending > tax which makes option E incorrect.