Question

Suppose that the bahavior of households and firms in an economy is determined by the following equations c = 90 + 0.75 y Ii 35 (intended investment) If for some reason income equaled 500 would there be unintended investment? if so, would inventories be excessive of depleted and by how much? What is the equilibrium level of income and output? what is the income/spending multiplier equal to in this model? if intended investment were to rise by 25 by how much would equilibrium income increase? use the income/spending multiplier?

Answer 1

C= 90 + 0.75Y

II = 35

At equilibrium level AD = Y

AD = Y = C + II

Y = 90 + 0.75 Y + 35

Y - 0.75 Y = 125

0.25Y = 125

Y = $ 500

Now, if Income =500 , then there would be no unintended investment because equilibrium level of income is 500 , there is no excess or depletion of inventories at this level of income.

Income/ Spending multiplier = 1/ 1-MPC = 1/ 1-0.75 = 1/0.25 = 4.

If intended investment were to rise by 25 , then equilibrium income would rise by (multiplier)(increase in investment) = (4)(25) = $ 100.

Equilibriu income would increase by $100 . That is, new equilibrium level of income = $(500+100) = $600