Question

1. Consider an economy in which autonomous consumption is 800, the marginal propensity to consume is 0.8, investment is 400, government spending is 500, taxation is 400, and net exports are 100.

A. What is the equilibrium GDP in this economy? Show your work.

B. What is the savings at this level of GDP? Show your work.

C. What are the spending and tax multipliers? Show your work.

D. If government spending increases by 200, what is the new equilibrium GDP and what is the increase over the original equilibrium GDP? Show your work.

E. If the government increases both spending and taxation by 200, what is the new equilibrium GDP and what is the increase over the original equilibrium GDP? Show your work.

Answer 1

Answer:

• 1800
• 500
• Spending multiplier =5 , Tax multiplier =4
• new GDP =2000 , Increase GDP level = 11.11%

• new GDP =1800 , Increase in GDP level = 0%

Explanation:

• Equilibrium GDP = C+I+G+net export

C = private consumption

I = investment

G = government consumption

Net export = export - import

800+400+500+100 = 1800

• Saving at GDP = (GDP-T-C) +(T-G)

(1800-400-800)+(400-500) = 500

• SPENDING  MULTIPLIER = 1 / 1 - MPC

= 1 / 1 - 0.8 = 5

        TAX MULTIPLIER = MPC /  1 - MPC

= 0.8/1-0.8

=0.8 / 0.20 = 4

• New equilibrium GDP = GDP + 200 = 2000

Increase in GDP level = (NEW GDP - OLD GDP / OLD GDP) *100

(2000-1800) / 1800 = 11.11%

• New Equilibrium GDP = C + I+ G + Net export

(800-200) +400 +(500+200) +100 = 1800

Increase in GDP level = (NEW GDP - OLD GDP / OLD GDP) *100

There is no change in GDP.