Suppose that the consumption function in a particular economy is given by the fo

Question

Suppose that the consumption function in a particular economy is given by the following table:

Disposable Income

(Billions of Dollars)

Consumption Expenditure

(Billions of Dollars)

Assuming that no taxes are imposed (and net exports are 0), what is the equilibrium value of GDP if government expenditures are $50 billion & intended investment is $50 billion?

Now, fill in the blanks using the data in the first table, supposing that taxes are 20% of GDP

GDP

(Billions of Dollars)

Consumption Expenditure

(Billions of Dollars)

Disposable Income

(Billions of Dollars)

Consumption Expenditure

(Billions of Dollars)

400 350 500 425 600 500 700 575 800 650

Explanation / Answer

(b)

In equilibrium,

Planned saving = Planned (intended) investment, where

Planning saving = Disposable income - Consumption

Since planned investment = $50 billion, planning saving = $50 billion

This holds true when disposable income = $400 bill & consumption = $350 bill.

So, equilibrium GDP = C + I + G = $(350 + 50 + 50) bill = $450 billion

(b)

When tax = 20% of GDP, Disposable income = GDP x 80% = 0.8 x GDP

So,

GDP = Disposable income / 0.8

GDP ($ bill) Disposable income ($ bill) Consumption ($ bill) 500 400 350 625 500 425 750 600 500 875 700 575 1,000 800 650

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