C = 200 + 0.75Yd; C = consumption function; Yd = disposable income (Y-T) T = 200

Question

C = 200 + 0.75Yd; C = consumption function; Yd = disposable income (Y-T)

T = 200; T = Tax revenue

I = 200; I = Investment

G = 300; G = Government expenditure

Yf = Full Employment RGDP (Potential RGDP) = 3,000

1. Estimate the equilibrium GDP level (income).

2. At the equilibrium level of output you estimated for Q1 above, estimate the aggregate consumption level

3. At the equilibrium level of output you estimated for Q1 above, estimate the aggregate saving level.

4. The MPC and MPS for the economy is respectively:

5. The expenditure multiplier for the economy is:

6. The tax multiplier for the economy is:

7. If the Tax amount is reduced from $200 to $100, estimate the equilibrium GDP level (income).

8. With Tax amount keeping at $200, if Government spending (G) is increased from previous level of $300 to $400, estimate the equilibrium level of GDP.

9. With Government spending keeping at $300, if the tax amount is increased from $200 to $300, estimate the equilibrium level of GDP.

10. With Tax amount keeping at $200, if government spending is reduced from $300 to $200, estimate the equilibrium level of GDP.

11. Using the data for potential RGDP in the above Macroeconomic model, and using the estimated equilibrium RGDP from Q1 answer, what is the level of GDP gap?

Explanation / Answer

1. Using the Expenditure approach to GDP,

Y=C+I+G

Y=200 + 0.75(Y-200)+200+300

Y=700+0.75Y-150

0.25Y=550

Y=2200

2. Aggregate Consumption Level

C=200+0.75(Y-T)

C=200+0.75(2200-200)

C=200+1500=1700

3. Y=C+S

Y-C=S

S=2200-1700=500

4.MPC is the coefficient of the disposable Income.

Here, MPC=0.75 and MPS=1-MPC

Hence, MPS=0.25

5. Expenditure Multiplier is the effect on income of a change in autonomous expenditures. The formula for the multiplier is=1/(1-c) . Here, c is the marginal propensity to consume.

=1/1-0.75

=1/0.25=4

6. The tax multiplier is calculated as -c/1-c= -0.75/0.25 =3

7. if the tax amount changes from 200 to 100, the equilibrium income changes as follows:

Y=C+I+G

Y=200+0.75(Y-100)+200+300

Y=700+0.75Y-75

0.25Y=625

Y=2500

8. If the government spending increases by 100 ( 300 to 400) the new equilibrium level of Income is calculated below:

Y=200+0.75(Y-200)+200+400

Y=800+0.75Y-150

0.25Y=650

Y=2600

9. With the tax increasing from 200 to 300, substitute the values in the equation to get the new equilibrium level of GDP.

Y=200+0.75(Y-300)+200+300

Y=700+0.75Y-225

0.25Y=475

Y=1900

10. With government spending reducing from 300 to 200, the new equilibrium Income is

Y=200+0.75(Y-200)+200+200

Y=600+0.75Y-150

0.25Y=450

Y=1800

11. GDP gap= Highest GDP(Y) - GDP(Y) of part 1

=2600-2200=400

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