You are given the following income-expenditures model for the economy of Vulcan.

Question

You are given the following income-expenditures model for the economy of Vulcan.

   C = 300 + .9Yd

           T = 200

           G = 300

            I = 250

What would the level of expenditures be if the economy were operating at $10,000?

Using your answer from, make a forecast for the future of the Vulcan economy and explain your reasoning.

The policymakers of Vulcan are considering balancing the budget. What would have to change for this to happen?

Using the government spending and tax multipliers, explain how balancing the budget would impact Vulcan’s macroeconomy.

Explanation / Answer

Use AE = Y

300 + 0.9(Y - 200) + 300 + 250 = Y

Y* = 6700

Now currently Y = 10000

Hence AE = 300 + 0.9(10000 - 200) + 300 + 250 = 9670. Since AE < Y, there will be unplanned inventories increase and firms would decrease their production which would reduce GDP

Balancing budget implies government spending cannot exceed taxes, G < or = T. Hence G should be reduced by 100 to make G = T = 200. Else T should be raised by 100.

Government spending multiplier is 1/MPS = 1/0.1 = 10 and tax multiplier = -MPC/MPS = -9.

Hence if budget is balanced, G is reduced by 100 and it will reduce GDP by 100 x 10 = 1000.

If budget is balanced and T is increased, it will increase by 100 and it will reduce GDP by 100 x 9 = 900.  

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