Problem 1 (30 points) Income (Y) Net Tax (T) Disposable Income (Y D ) Consumptio
ID: 1208657 • Letter: P
Question
Problem 1 (30 points)
Income (Y)
Net Tax (T)
Disposable Income (YD)
Consumption (C)
Saving (S)
Investment (I)
Gov. Spending (G)
TE
10,000
1,000
9,000
7,700
1,300
2,000
1,500
11,200
12,000
1,000
11,000
9,300
1,700
2,000
1,500
12,800
13,000
1,000
12,000
10,100
1,900
2,000
1,500
13,600
15,000
1,000
14,000
11,700
2,300
2,000
1,500
15,200
16,000
1,000
15,000
12,500
2,500
2,000
1,500
16,000
18,000
1,000
17,000
14,100
2,900
2,000
1,500
17,600
20,000
1,000
19,000
15,700
3,300
2,000
1,500
17,200
c) What is the equilibrium output level?
d) If the current output level is 15,000, what would likely happen to the output level next year? Why?
e) By how much will the equilibrium output level increase (decrease) if the planned investment falls by 500?
f) By how much will the equilibrium output level increase (decrease)if the tax (T) decreases by 400?
g) By how much will the equilibrium output level increase (decrease) if the government spending (G) decrease by 800?
h) By how much will the equilibrium output level increase (decrease) if the government spending (G) decrease by 300 and at the same time, the government cuts taxes by the same amount of 300?
Income (Y)
Net Tax (T)
Disposable Income (YD)
Consumption (C)
Saving (S)
Investment (I)
Gov. Spending (G)
TE
10,000
1,000
9,000
7,700
1,300
2,000
1,500
11,200
12,000
1,000
11,000
9,300
1,700
2,000
1,500
12,800
13,000
1,000
12,000
10,100
1,900
2,000
1,500
13,600
15,000
1,000
14,000
11,700
2,300
2,000
1,500
15,200
16,000
1,000
15,000
12,500
2,500
2,000
1,500
16,000
18,000
1,000
17,000
14,100
2,900
2,000
1,500
17,600
20,000
1,000
19,000
15,700
3,300
2,000
1,500
17,200
Explanation / Answer
c. The equilibrium is attained where the income equals the expenditure, that is, where Y equals the TE. This is at 16,000 level.
d. At the 15000 level of output, the TE at this point is 15200, which means that the expenditure exceeds the income level and to fund the consumption level, the consumers would dissave and make consumption. In the next phase, the income would be higher as the multiplier effect would come into play (as the consumption is made through dissavings). The economy then moves towards the equilibrium point.
e. When the investment falls by $500, the mpc = 0.5 (change in consumption/change in income). The investment multiplier = 1/1-MPC or 1/1-0.8 or = 5. if the investment falls by $500, the fall in income is = -500*5 = -$2500. Thus if the investment falls by $500 then the equilibrium income would fall by $2500.
f. If the level of taxes fall, the disposable income rises and that increases the level of consumption. The increase in output would be = -MPC/1-MPC times the change in tax.
-0.8/0.2 times (-400) = $1600, is the increase in output.
g. The equilibrium output would decrease with the decrease in the level of government spending as it is a part of the AD.
the government multiplier = 1/1-MPC or 1/1-0.8 or 1/0.2 = 5.
Now if the government spending is reduced by $800, the reduction in the output would be multiplier times, that is,
5*800 = $4000 decrease in the output.
h. The output would fall if the government decreases its spending and taxes at the same time and by the same level. The balanced budget multiplier comes into play ,which has a value = 1. And any increase or decrease (the same value) of the spending or taxes would increase or decrease the income/output by the same level.
Hence the output would decrease by the same amount $300.
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