Question

#1:   In a small open economy S = -200 + 0.25Y, M = 100 + 0.25Y, I = 200, and X = 300. The equilibrium level of income is:

A. $800

B. $1,200

C. $900

D. $1,100

Answer 1

Answer 1

The correct answer is (B) $1200

Equilibrium occurs when Aggregate Expenditure(AE) = Income(Y)

AE = C + I + G + X - M

where C = Consumption

When S = So + sY => C = -So + (1 - s)Y

Here So = Autonomous saving = -200 and s = Marginal Propensity to save = 0.25

=> C = 200 + 0.75Y

At equilibrium Y = AE

=> Y = C + I + G + X - M = 200 + 0.75Y + 200 + 300 - (100 + 0.25Y)

Here G = 0

=> Y = 600 + 0.75 - 0.25 = 600 + 0.5

=> 0.5Y = 600

=> Y = 1200

Hence Equilibrium Level of Income = $1200

Hence, the correct answer is (B) $1200