24 Your research into a nation has yielded the following information: Autonomous

Question

24

Your research into a nation has yielded the following information: Autonomous expenditure (A) = $300 Gross investment (I) = $200 Government purchases (G) = $300 Net exports (NX) = $225 Taxes (T) = $300 MPC = 0.75 Instructions: Use a negative sign (-) when necessary. Substitute the values above into the equation: AE = A + [MPC x (Y - T)] + I + G + NX. Then state the abbreviated equation for aggregate expenditures (AE). AE= + Y Knowing that AE = Y at the equilibrium level of output, what is the equilibrium level of output for this nation? Y_e: What is the tax multiplier for this economy? If taxes decrease by S40. from S300 to S260, what is the new equilibrium level of output? Ye: With this new tax level of $260, the government will: have enough tax revenue to pay for all their imports. collect more in taxes than they spend on government purchases. spend more on government purchases than they collect in taxes. not tax businesses enough.

Explanation / Answer

(a)

AE = 300 + [0.75 x (Y - 300)] + 200 + 300 + 225

= 1025 + 0.75Y - 225

AE = 800 + 0.75Y

(b)

Since AE = Y,

Y = 800 + 0.75Y

(1 - 0.75)Y = 800

0.25Y = 800

Y = 3,200

(c)

Tax multiplier = - MPC / (1 - MPC) = - 0.75 / (1 - 0.75) = - 0.75 / 0.25 = - 3

(d)

If tax decreases by $60, output will increase by $60 x 3 = $180.

New equilibrium output = $(3,200 + 180) = $3,380

(e)

When new tax = $260 and government purchases = $300, the government will spend more on government purchases than they collect in taxes (since $300 > $260).

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