Question

Here are some facts about the economy of Inferior.

Marginal propensity to consume 3/5 marginal propensity to import 0 autonomous consumption 4 exports 0 private investment 20 income tax rate 0 government expenditures 0

Income consumption investment government aggregate expenditures expenditures 0

10

20

30

40

50

60

70

80

90

Suppose that investment rises to 28. What is the new GDP?

Answer 1

Answer is 80

Aggregate Income= Consumption(C)+ Private Investment (I)+ Government Expenditure(G)+ Exports(E)-Imports(M)

where,

Consumption(C)= Autonomous Consumption (C0)+[Marginal Propensity to consume (c)*(Income(Y)-Tax(T)]

Private Investment (I) & Government Expenditure(G) and Exports (E) are autonomous expenditure (according to question)

Imports(M) = marginal propensity to import (m) *Income/GDP(Y)

Given,

c =3/5, C0 = 4, T=0, I=20, G =0, E=0, m=0 therefore M =0,

Putting Values in the aggregate income function,

Y= C(0)+c(Y-T)+ G+I+E-mY

Y= 4+(3/5(Y-0))+ 0+ 20+0+0

Y= 24+ 3/5Y

Y-3/5Y =24

2/5Y= 24

Y= (24*5)/2=60

Now Suppose Investment(I) increases to 28, New GDP (Y*) will be

Y*= 4+(3/5(Y-0))+ 0+ 28+0+0

2/5Y*= 32

Y*= (32*5)/2

Y*= 80