VII. Assume the basic three sector model: Y = C + I + G Where Tx = Tx o and I f

Question

VII. Assume the basic three sector model: Y = C + I + G
Where Tx = Tx o and I f ( Y with MPC = 0.8
Also, assume the following IS and LM schedules

For the IS, at i = 10%, Y = 1000
and at i = 8%, Y = 1200
and at i = 6%, Y = 1400
and at i = 4%, Y = 1600

And for the LM curve, at i = 10%, Y = 1800
and at i = 8%, Y = 1600
and at i = 6%, Y = 1400
and at i = 4%, Y = 1200

Now increase the level of government spending by $10 billion.

a. According to the applicable Keynesian formula multiplier, how much
should that $10 billion increase in government spending increase the level of
income?

b. According to your IS – LM curves, how much would that $10 billion
increase in government spending increase the level of income? (You may
interpolate/estimate the change in income if necessary. However, make it
a tight estimation/interpolation)

c. Is there a difference in the answer you gave for 2a versus 2b?

Explain

Explanation / Answer

a) Keynesian multiplier = 1/(1-MPC) = 1/0.2 = 5

Increase in income = 5*10 billion = $50 billion

b) It would be the same

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