1. Suppose that the economy can be described by the following equations: C-200+
ID: 1104632 • Letter: 1
Question
1. Suppose that the economy can be described by the following equations: C-200+ (8/9)*DI I- 500 G = 800 (X-M)-0 a. If national income (Y) increased by $1, by how much would consumption increase? What is the name of this concept? b. Find the equilibrium level of output. c. The budget for this fiscal year increases government spending by $100. i) Sketch the effect of the increase in government spending. ii) Calculate the new equilibrium level of income. ii) Calculate the change in income and compare to the increase in government spending. Comment iv) Given your answer in part (iii), what should the value of the multiplier be? v) Compute the actual value of the multiplier. Now G assumes its original value of G-800. d. Congress decreases the tax rate from (1/2) to (1/4) i) Sketch the effect of the decrease in the tax rate. ii) Calculate the new equilibrium level of income. e. Suppose that voters care more about real national income than the level of the deficit. If you were running for Congress this year (and you wanted to win the election), would you promise to increase or to decrease government spending? Why?Explanation / Answer
a) Multiplier = 1/ (1 - MPC + MPC.t) = 1/(1 - 8/9 + 8/9 x 1/2) = 1/(1/9 + 4/9) = 9/5 = 1.8
Change in Y = Change in C x Multiplier
1 = Change in C x 1.8
Change in C = 1/1.8 = $ 0.55
b. Y = C + I + G + X - M
Y = 200 + 8/9Y + 500 + 800 + 0
Y - 8/9Y = 1500
1/9Y = 1500
Y = 1500 x 9 = 13,500
c) (i) Y = C + I + G + X - M
Y = 200 + 8/9Y + 500 + (800 + 100) + 0
Y/9 = 1600
ii) Y = 1600 x 9 = $ 14,400
iii) Change in G = 100
Change in Y = 14,400 - 13,500 = 900
iv) Multiplier = Change in Y / Change in G = 900/100 = 9
v) Actual value of multiplier = 1/ (1 - MPC + MPC.t) = 1/(1 - 8/9 + 8/9 x 1/2) = 1/(1/9 + 4/9) = 9/5 = 1.8
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