Question

Consider an economy in the short-run described by the following equations:

Z = C + I + G

G = 500

T = 500

C = 250 + 0.75(Y – T)

I = 425 + 0.05Y

a. Solve for equilibrium output Y.
b. What is the value of the expenditure multiplier now? Why would the expenditure multiplier be bigger?
c. Now, if G increases to 600, by how much will Y increase?
d. Suppose that bo= 425 increases to 525. By how much will output increase? By how much will investment increase? By how much will total saving increase?

Answer 1

Answer a : Equiliburm Output (Y) = C+I+G +NX

Y = 250+0.75(Y-500)+425+0.05Y+500

Y =1125+0.75Y-375

Y = 750 +0.75Y

0.25Y =750

Y =3000

Here, the total output of an economy is 3000

Answer b :

Changes in output = 400

Changes in government spending = 100

Expenditure multiplier = 400/100 =4

The expenditure multiplier be bigger because increase in autonoums spending lead to injection in an economy. As government spend more people recieved more income and there is more consumpation lead to increased in GDP of the country.

Answer c : When Government expenditure increases 600

than Y = 1225+0.75 Y

0.25Y =1225

Y = 3400

Answer d : Here, bo is increased to 525 than

I =525+0.05Y

Y =C+I+G

Y = 250+0.75(Y-500)+525+0.05Y+500

Y= 1225+0.75Y -375

0.25Y = 850

Y = 3400

Output increases by 400

Investment increases by 120

Old savings = Y-C-G = 3000-2125-500 = 375

New savings = 475

Saving increases by 100