ADVANCED ANALYSIS Assume that the consumption schedule for a private open econom

Question

ADVANCED ANALYSIS  Assume that the consumption schedule for a private open economy is such that consumption is:

C = 60 + 0.8Y

Assume further that planned investment Ig and net exports Xn are independent of the level of real GDP and constant at Ig = 40 and Xn = 10. Recall also that, in equilibrium, the real output produced (Y) is equal to aggregate expenditures:

Y = C + Ig + G + Xn

Instructions: Round your answers to the nearest whole number.

a. What is the equilibrium level of income or real GDP for this economy?

     Equilibrium GDP (Y) = $______

b. What happens to equilibrium Y if Ig changes to 20?

     Equilibrium GDP (Y) = ______

     What does this outcome reveal about the size of the multiplier?

     Multiplier = .

Explanation / Answer

a)

C = 60 + 0.8Y

Ig = 40

Xn = 10

at equilibrium  

Y = C + Ig + G + Xn

= 60 + 0.8Y + 40 + 10

Y = 110 + 0.8Y

Y - 0.8Y = 110

0.2Y = 110

Y = 550

so equilibrium Y = 550

b)

Now    Ig = 20

So

Y = C + Ig + G + Xn

= 60 + 0.80Y + 20 + 10

Y = 90 + 0.8Y

Y - 0.8Y = 90

0.2Y = 90

Y = 450

Equilibrium Y has reduced by 100

c)

Multiplier K = 1/(1 - MPC)

we have c = 60 + 0.8y

so MPC = 0.8

K = 1/(1 - 0.8)

= 1/0.2

= 5

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