Given the following information (in billions of dollars) answer the questions be
ID: 1213121 • Letter: G
Question
Given the following information (in billions of dollars) answer the questions below: Autonomous Consumption = $500 billion, Investment is $1,000 billion, Government Spending is $250 billion and the MPC = 0.75.
Income
Consumption
Saving
Aggregate Expenditures
$0
$1,000
$2,000
$3,000
$4,000
$5,000
$6,000
$7,000
$8,000
(a) Fill in the numbers for the Consumption and Saving.
(b) Determine the equilibrium level of income and explain how you determined your answer.
(c) If the Full Employment level of income is $10,000, then how much government spending is need to get this economy to be at equilibrium at full employment (assuming prices are constant).
(d) Using the Spending Multiplier, please explain your answer in (c) above.
Income
Consumption
Saving
Aggregate Expenditures
$0
$1,000
$2,000
$3,000
$4,000
$5,000
$6,000
$7,000
$8,000
Explanation / Answer
A) Note that the consumption function is C = 500 + 0.75Y. Savings are the difference between income and consumption, the unconsumed part of the income. The table shows the required data on Savings and Consumption.
B)
The Keynesian Cross articulates the relationship between Planned Expenditure and Actual Expenditure. Planned Expenditure is the amount households (in the form of Consumption, C) firms (in the form of Investment, I) and government (in the form of government spending, G) would like to spend on goods and services. This is expressed as:
PE = C + I + G
Substituting the respective values in the equation, it turns out that PE = Y occurs when Y = $7000. At this level Consumption is 500 + 0.75*7000 = $5750, Investment = $1000 and Government spending is $250. Combined actual expenditure is 5750 + 1000 + 250 = $7000 which is equal to this stage income of $7000.
Another way is to calculate this. Note that eat equilibrium,
AE = PE
500 + 0.75Y + 1000 + 250 = Y
1750 = 0.25Y
Y = $7000.
Hence, equilibrium income is $7,000
C) If the Full Employment level of income is $10,000, the the GDP gap is $3000 since current GDP is $7000. This gap can be filled if the government adopts an expansionary policy by increasing government spending.
G should be increased in such a way that it, along the spending multiplier, increases the GDP by exactly $3000.
When government spending rises, it raises the equilibrium level of income multiple times. The size of this government-purchases-multiplier can be assessed by:
Y/G = 1/1-MPC
Where MPC is the marginal propensity to consume. For the consumption function C = 500 + 0.75Y , the value of MPC is 0.75. Here G = 25.
Substitute the value of MPC in the multiplier
3000/G = 1/1-0.75
3000/G = 4
G = 3000/4 = $750
This implies that the income level rises by $3000 when government spending rises by $750.
D) As exlained,
When government spending rises, it raises the equilibrium level of income multiple times. The size of this government-purchases-multiplier can be assessed by:
Y/G = 1/1-MPC
Where MPC is the marginal propensity to consume. For the consumption function C = 500 + 0.75Y , the value of MPC is 0.75. Here G = 25.
Substitute the value of MPC in the multiplier
3000/G = 1/1-0.75
3000/G = 4
G = 3000/4 = $750
GDP Consumption Savings Investment Government spending AE 0 500 -500 1000 250 1750 1000 1250 -250 1000 250 2500 2000 2000 0 1000 250 3250 3000 2750 250 1000 250 4000 4000 3500 500 1000 250 4750 5000 4250 750 1000 250 5500 6000 5000 1000 1000 250 6250 7000 5750 1250 1000 250 7000 8000 6500 1500 1000 250 7750Related Questions
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