Question

The MPC for a closed economy is 0.75. Autonomous consumption is $500, investment is $300, and government spending is $400.

a) What is the equilibrium level of real GDP?

b) If business increases planned investment expenditure by 300 to 400, what is the new equilibrium real GDP?

c) What is the slope of the AE function in this economy and the value of the multiplier?

Answer 1

a)

the equilibrium GDP is at

Y=C+I+G

Y=real GDP

C=consumption

I=investment  

G=governent spending

The consumption function is the form of

C=A+BY

A=autonomus consumption=500

B=MPC=0.75

C=500+0.75Y

using values and equations

Y=500+0.75Y+300+400

0.25Y=1200

Y=$4800

the equilibrium GDP is $4800

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b)

I=400 instead of 300

Y=500+0.25Y+400+400

0.25Y=1300

Y=$5200

the new equilibrium GDP is $5200

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c)

the AE funtion is

AE=C+I+G

AE=500+0.75Y+300+400

AE=1200+0.75Y

the slope of AE funtion is 0.75

Multiplier =1/(1-slope)

=1/(1-0.75)

=4

the multiplier is 4.