Assume that the consumption schedule for a private open economy is such that con

Question

Assume that the consumption schedule for a private open economy is such that consumption C=50+0.8Y. Assume further that planned investment Ig and net exports Xn are independent of the levelof real GDP and constant at Ig=30 and Xn=10. Recall also that, in equilibrium, the real output produced (Y) is equal to aggregate expenditures: Y=C+Ig+Xn.

A.) Calculate the equilibrium level of income or real GDP for this economy.

B.) What happens to the equilibrium Y if Ig changes to 10? What does this outcome reveal about the size of the multiplier?

Explanation / Answer

1. substitute c into the equation along with the other variables Y=C+Ig+Xn Y = 50+0.8Y + 30 +10 Y = 90 + 0.8Y Y(1-0.8) = 90 Y = 90/0.2 = 450 2. If Ig changes to 10, the 90 in the numerator goes down to 70 i.e. Y = 350 and the whole thing goes down by 20/0.2 = 100. the size of the multiplier changes whatever is on top by 5 times (i.e. 1/0.2 = 5)

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