Question

#10. In a small open economy S = -200 + 0.25Y, M = 100 + 0.25Y, I = 200, and X = 300. Suppose saving decreases by $50 at each income level. The equilibrium level of income changes from ______ to ______.

A. $1,200, $1,100

B. $1,100, $1,200

C. $900, $700

D. $1,200, $1,300

E. None of the above

Answer 1

Answer 10

The correct answer is (D) $1,200, $1,300

First lets Find Initial Consumption schedule:

C = -Sa + MPC*Y

S = Sa + MPS*Y = -200 0.25Y  

Here Sa = Autonomous saving and MPC = Marginal Propensity to consume and MPC = 1 - MPS = 1- 0.25 = 0.75

=> C = 200 + 0.75Y

At equilibrium Y = AE and AE = C + I + G + NX and NX = X - M

=> Y = 200 + 0.75Y + 200 + 0 + 300 - (100 + 0.25Y)

=> 0.5Y = 600 => Y = 1200

Now suppose saving decreases by $50 at each income level, this means Autonomous Saving decreases from -200 to -250

Hence Now,

C = 250 + 0.75Y

At equilibrium Y = AE and AE = C + I + G + NX and NX = X - M

=> Y = 250 + 0.75Y + 200 + 0 + 300 - (100 + 0.25Y)

=> 0.5Y = 650 => Y = 1300 ----------------New Income

Hence Income Increases from 1200 to 1300

Hence, the correct answer is (D) $1,200, $1,300