2. On the planet Omicron Persei 9, economists estimate the following: Output (In

Question

2. On the planet Omicron Persei 9, economists estimate the following:
Output (Income) $2,000
Government Purchases $200
Net Taxes $200
Planned Investment Spending $300
Citizens consume 75% of their disposable income (marginal propensity to consume is 0.75).

a. Find consumption and planned aggregate expenditure.
b. Carefully explain why and how this economy is not in equilibrium.
c. Explain what business will do in response to this disequilibrium.
d. Explain what, in turn, will happen to income.
e. A government official suggests increasing government purchases by $100. What is the main benefit of this proposal? What is the main drawback of this proposal? Give specific numerical answers where possible.

Explanation / Answer

a)disposable income =2000-200-200-300 =1300 consumption =mpc*disposable income = 0.75*1300 =975 planned aggregate expenditure = disposable income = 1300 b)income =Y = 975 +300+200+200 = 1675 which is not equal to 2000 . hence economy is not in equilibrium .. c) consumption is less than expenditure hence business will lower its supply d)and hence income decreases evebtually. e)by increasing government purchase by 100 disposable income will be 1200 hence consumption =0.75 *1200 =900 hence Y = 900+300+300+200=1700 ie greater than 1675 hence income increases in this case but drwaback is that the disposable income decreases for people

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