Question

Suppose that the following is true for an economy: C = 50 + .8( DI) T = 150 G = 150 NX = - 50 Note : * you are not given the value of I a.) Solve for the oversimplified multiplier in this economy. b.) Now suppose that NX increases by 7. Solve for the CHANGE in equilibrium real GDP ( on the demand side) . ( c.) Show, on an AE graph, how both the change in NX and the resulting change in Y* can be represented ( in general; you don’t need to show any specific numbers; be sure to draw everything you need to demonstrate ( in general) an equilibrium real GDP ( on the demand side)). Now suppose that Investment decreases, causing equilibrium Real GDP ( on the demand side) to decrease by 40 ( Note: the Multiplier ( from part a.)) is still valid). d.) By how much did Investment decrease ( give a numerical answer)? ( e.) By how much will the AD Curve shift ( give a numerical answer)?

Answer 1

A) Multiplier=1/(1-MPC)

Multiplier=1/(1-0.8)

Multiplier=1/0.2=5

B) Change in equilibrium income= Change in autonomous spending* multiplier

Change in equilibrium income=7*5=35

C)

D) Change in equilibrium income= change in investment/ autonomous spending. * Multiplier

-40= change in investment*5

Change in investment=-40/5=-8

So investment Decrease by 8.

E) Aggregate demand is equal to income at equilibrium.

So decrease in equilibrium income by 40, so aggregate demand Decrease ny 40.

Aggregate demand will shift left by 40 .