Suppose that the government of Lumpland is enjoying a fat budget surplus with fi

Question

Suppose that the government of Lumpland is enjoying a fat budget surplus with fixed government expenditures of G = 150 and T = 200. Assume that consumers of Lumpland behave as described in the following consumption function: C = 150 + 0.75 (Y - T )

Suppose further that investment spending is fixed at 100. Calculate the equilibrium level of GDP in Lumpland. Solve for equilibrium levels of Y, C, and S. Next, assume that the Republican Congress in Lumpland succeeds in reducing taxes by 20 to a new fixed level of 180. Recalculate the equilibrium level of GDP using the tax multiplier. Solve for equilibrium levels of Y,C, and S after the tax cut and check to insure that the multiplier worked. What arguments are likely to be used in support of such a tax cut?

Explanation / Answer

In equilibrium: AD = Y

Where, AD is the aggregate demand.

AD = C + I + G

= 150 + 0.75 (Y

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