4. Suppose that there is a closed economy with 1= 1 00 A. Calculate the governme

Question

4. Suppose that there is a closed economy with 1= 1 00 A. Calculate the government expenditure multiplier. C-300+0.8Y G-200 B. What is the equilibrium level of output? C. At the equilibrium level of output in B), what are the values of consumption and savings? D. Base on the following descriptions of crowding out effect Md; from every $5 changes in Md; changes by $3; (1) every $10 changes in G leads $5 changes in (2) interest rate (r) changes by 1% resulting (3) interest rate changes by 1%, investment Find out the final change of equilibrium output if government would like to increase government spending by $100

Explanation / Answer

C= 300+0.8 Y

I= 100

G=200

(A) Government expenditure multiplier = 1/1-M.P.C

= 1/1- 0.8 = 1/0.2 = $5

(B) Equilibrium level of output (When AD=Y)

AD= C+I+G =Y

(300+0.8 Y)+ 100 + 200 = Y  

Y = $3000

(C) At the equilibrium of output; Consumption,C = 300+0.8 Y = 300 + 0.8(3000)

= 300+ 2400 = $2700

Savings= Y-C = 3000-2700 = $300.

(D) Every $10 changes in G leads $5 changes Md , Therefore when Government spending(G) increases by $100 then monay demand(Md) increases by $50.

Interest rate (r) changes by 1% resulting from every $5 changes in Md . Therefore when Md increase by $50 then, interest increases by 10%.

Interest rate changes by 1% , investment changes by $3. Therefore, when interest rate increases by 10% then, investment decreases by $30.

Hence, innew equilibrium level of output is

Y= C+ (I+change in I )+ (G+change in G).

Y= 300+ 0.8 Y + (100-30) + (200+100)

Y= $3350.

Final change in output = $(3350-3000) = $350.

  

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