Question

On Sun Island, a closed economy, the consumption function is
c = 1 + 0.75(y - t) billions of 1992 dollars.
The government of Sun Island levies taxes of $1 billion a year and buys
goods and services worth $1 billion a year. Investment on Sun Island is $0.5
billion a year.

5. If investment increases by $0.25 billion a year, what is the change in real GDP? (3 points)

6. Go back to the initial equilibrium level of GDP. The government plans to increase its expenditures on goods and services by $0.25 billion a year. What are the resulting changes in consumption and saving? (3 points)

7. Explain the adjustment process to the new equilibrium. (3 points)

8. How does the government’s expenditures on $0.25 billion worth of goods and services get financed? (3 points)

9. Show that leakages from the circular flow equal injections into it. (3 points)

10. Go back to the initial equilibrium expenditure. The government plans to increase expenditures on goods and services by $0.25 billion and to finance its expenditure by an increase in autonomous taxes. What is the new equilibrium expenditure? (5 points)

Answer 1