Question

Use the following information about the economy of Banana Land to answer questions 14-16.

C = 2000 + 0.75Yd

T = 200

G = 400

I = 500

(Yd is disposable income)

If taxes in Banana land increase by $100, equilibrium output decreases by?

a) $300

b) $400

c) $500

d)$100

Answer 1

Equilibrium output is when AE= Y

Aggregate expenditure , AE= C+G+I

= 2000+ 0.75(Y-200) + 400+ 500

= 2000 + 0.75Y - 150 + 400+500

= 2750 + 0.75Y

At equilibrium AE= Y

Y = 2750 = 0.75Y

Y- 0.75Y= 2750

0.25Y = 2750

Y = $11000.

If taxes in Banana land increase by $100 , then AE= 2000+ 0.75(Y-300) + 400+ 500

= 2675 + 0.75Y

At equilibrium AE=Y

Y = 2675+ 0.75Y

0.25Y= 2675

Y= $10700

This implies that when tax increases by $100 , equilibrium output decrease by $(11000-10700)=$ 300.

Hence, option(A) is correct.