Problem 3 The accompanying table shous gross domestic product (GDP), disposable

Question

Problem 3 The accompanying table shous gross domestic product (GDP), disposable in- come (YD), consumer spending (C), and planned investment spending (IPlanned) in an econ- omy. Assume there is no government or foreign sector in this economy. Make sure you show your work in your answers. GDP YDPianed AEPianned unplanned $0 80 $100 300 400 8001,000 300 300 1,600 1,300300 300 300 1,200420700 1,600 2,000 2,40 2, 3,200 1,200 2,000 2,800 1,600 28001.900 2,200 3,200 2,500300 (1) Complete the table by calculating planned aggregate spending (ABPlanned) and un planned inventory investment (lUnplanned). (2) Derive the aggregate consumption function from the table. (3) Calculate income-expenditure equilibrium GDP (4) Calculate the value of the multiplier. (0) I plannod investment spending falls to $200 billion, what wil be the new oquilibrium GDP?

Explanation / Answer

(1)

(a) AEplanned = C + Iplanned

(b) When GDP > AEplanned, Iunplanned < 0 & When GDP < AEplanned, Iunplanned > 0

(2)

Aggregate consumption: C = a + bYD where a Autonomous consumption, b: MPC

When YD = 0, C = $100 billion = a

When YD = 400, C = 400

400 = a + 400b

400 = 100 + 400b

400b = 300

b = 0.75

Consumption function: C ($ billion) = 100 + 0.7YD

(3)

In equilibrium, GDP = AEplanned = $1600 billion

(4) MPC = 0.75

Multiplier = 1 / (1 - MPC) = 1 / (1 - 0.75) = 1 / 0.25 = 4

(5)

In new equilibrium, GDP = AEplanned = $1200 billion

GDP C Iplanned AEplanned Iunplanned 0 100 300 400 400 400 400 300 700 300 800 700 300 1000 200 1200 1000 300 1300 100 1600 1300 300 1600 0 2000 1600 300 1900 -100 2400 1900 300 2200 -200 2800 2200 300 2500 -300 3200 2500 300 2800 -400

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