2. Goods Market Equilibrium (25 points) Consider the following economy Y = Ys. C

Question

2. Goods Market Equilibrium (25 points) Consider the following economy Y = Ys. C 20 + 0.8y 580. Assume correct expectations and solve for the equilibrium values of output, consump- tion, and savings 3. Multiplier (25 points) Now, consider the following system of equations Y=C+I, C 20 + 0.8Y. 1 = 580 Compute the new equilibrium values and the difference in output, consumption, and savings relative to the initial equilibrium when investment increases by 20 units. Show that the increase in output can also be determined via the investment multiplier. 4. Government Activity (25 points) Extend the model from question 2 by adding government activity. The government levies a tax, ? 0.2, on income and spends G 20. Compute the value of the nvestment multiplier

Explanation / Answer

2)

Y = C+I

Y = 20 + 0.8Y + 580

Y – 0.8Y = 600

Y(1-0.8) = 600

Y = 600 / 0.2

     = 3,000

Output = 3,000

Consumption = 20 + 0.8 (3000)

              = 20 + 2400

              = 2420

Saving = Income – consumption

           = 3000 – 2420

          = 580

3)

Multiplier = 1/1—MPC

                 = 1/ 1- 0.8

        = 1/0.2

        = 5

Increase in income = 5* 620

                     = 3100

Output = 3100

Consumption = 20 + 0.8(3100)

                       = 20 + 2480

               = 2500

Increases by 80

Saving = 600

Increases by 20

Investment multiplier = 5

Increase in investment =20

Total increase in income or output = 20*5

= 100

4)

Tax multiplier = MPC/ 1-MPC

              = 0.8 / 1- 0.8

= 4

Value of tax multiplier is 4

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