Given the following for the Macro Economy answer the following question. In this

Question

Given the following for the Macro Economy answer the following question. In this economy, we have an MPC equal to 0.75 Autonomous Consumption of $500 billion. Planned Investment (I) of $1000 billion. Government spending (G) of $2000 billion and Net Taxes (T) of $1000 billion.

a) fill in the missing data in the table for T, Yd, C, S, and AE

Y:

$2000

$3000

$4000

$5000

$6000

$7000

$8000

$9000

$10000

$11000

b) determine the equilibrium level of Aggregate Income (Ye). Please state the reason for your answer.

c) calculate the Spending Multiplier

d) If this economy had a full employment level of income equal to $15000 billion what Macroeconomic condition is this economy experiencing?

e) Using the spending multiplier, determine the change in G that is needed to get this economy to be in equilibrium at full employment. Please show your work

f) Using the spending multiplier, determine the change in T that is needed to get this economy to be in full equilibrium at full employment. Please show your work.

Explanation / Answer

(a)

Working notes:

(i) Yd ($ Billion) = Y - T = Y - 1,000

(ii) Consumption (C) ($ Billion) = 500 + 0.75(Yd) = 500 + 0.75(Y - 1,000) = 500 + 0.75Y - 750 = 0.75Y - 250

(iii) S = Y - C

(iv) AE = C + I + G

Therefore:

(b)

In equilibrium, Y = AE, which holds true for Y = AE = $11,000 billion

Ye = $11,000 billion

(c)

MPC = 0.75

Multiplier = 1 / (1 - MPC) = 1 / (1 - 0.75) = 1 0.25 = 4

(d)

Since equilibrium income is less than full employment income ($11,000 billion < $15,000 billion), the economy is in recession.

(e)

Recessionary gap = $(15,000 - 11,000) Billion = $4,000 billion

Required increase in G = $4,000 billion / 4 = $1,000 billion

(f)

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

So, as Tax falls by $1, Income rises by $3.

To increase Income by $4,000 billion, required decrease in T = $4,000 billion / 3 = $1,333.33 billion

Y T Yd C S I G AE ($ Billion) ($ Billion) ($ Billion) ($ Billion) ($ Billion) ($ Billion) ($ Billion) ($ Billion) 2,000 1,000 1,000 1,250 750 1,000 2,000 4,250 3,000 1,000 2,000 2,000 1,000 1,000 2,000 5,000 4,000 1,000 3,000 2,750 1,250 1,000 2,000 5,750 5,000 1,000 4,000 3,500 1,500 1,000 2,000 6,500 6,000 1,000 5,000 4,250 1,750 1,000 2,000 7,250 7,000 1,000 6,000 5,000 2,000 1,000 2,000 8,000 8,000 1,000 7,000 5,750 2,250 1,000 2,000 8,750 9,000 1,000 8,000 6,500 2,500 1,000 2,000 9,500 10,000 1,000 9,000 7,250 2,750 1,000 2,000 10,250 11,000 1,000 10,000 8,000 3,000 1,000 2,000 11,000

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