2. The following data represent the economy of Mayberry: C=100+0.5Yd, T=2000, G=

Question

2. The following data represent the economy of Mayberry: C=100+0.5Yd, T=2000, G=2000, I=200 (a) Calculate the equilibrium level of output. Graph your solution. (b) If the government spending increases by 100 what is the new equilibrium level of output? Use the government spending multiplier. (c) If the government increases taxes by 100 what is the new equilibrium level of output? Use the tax multiplier. (d) If the government increases taxes and spending by 100 what is the new equilibrium level of output? (e) Calculate the equilibrium level of output in case where taxes depend on income according to the following: T=-50+0.25Y.

Explanation / Answer

a) Y = C + I + G

Y = 100 + 0.5(Y - T) + 200 + 2000

Y = 2100 + 0.5Y - 0.5(2000) + 200

0.5Y = 2300 - 1000

0.5Y = 1300

Y = 2600

b) Change in Y = Change in G / (1 - MPC)

Change in Y = 100/(1 - 0.5) = 200

So, new equilibrium level of output increases by 200. New equilibrium output = 2600 + 200 = 2800

c) Change in Y = - MPC x Change in taxes / (1 - MPC) = - 0.5 x 100/(1 - 0.5) = - 100

It implies new equilibrium output decreases by 100.

New equilibrium output = 2600 - 100 = 2500

d) Change in Y = [Change in G / (1 - MPC)] + [- MPC x Change in Taxes / (1 - MPC)]

= 200 - 100 = 100

New equilibrium level of output increased by 100 i.e. 2700

e) Y = C + I + G

Y = 100 + 0.5(Y + 50 - 0.25Y) + 200 + 2000

Y = 2300 + 0.5(0.75Y + 50)

Y = 2300 + 0.375Y + 25

Y - 0.375Y = 2325

0.625Y = 2325

Y = 3720

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