Question

Assume the following:      C = $200 +.75DI

                                          I = $100

                                          G = $300

                                          Xn =   $50

Calculate the equilibrium level of output. What is the multiplier? Show the equilibrium level of output graphically. (Assume government expenditures are the result of deficit spending).

Answer 1

C = $200 + 0.75 DI

Here, in the Consumption Function, a = autonomous consumption = 200 and b = MPC (Marginal Propensity to Consume) = 0.75 and DI = Disposable Income = Y - T (GDP level minus Taxes). In the question, Taxes, T are not given, so we assume T = 0.

So, Modified C = $200 + 0.75 Y

Equilibrium Level of output / GDP = Y = C + I + G + Xn = $200 + 0.75Y + $100 + $300 + $50 = $650 + 0.75Y

Y-0.75Y = $650

Y(1-0.75) = $650

0.25Y = $650

Y = $650/0.25 = $2600

Multiplier = 1/(1-MPC) = 1/(1-b) = 1/(1-0.75) = 1/0.25 = 4