Suppose the closed private economy is described by the following equations: C =

Question

Suppose the closed private economy is described by the following equations: C = $90 + 0.8%, and i-S50 (a) What is the value of autonomous spending? of the spending multiplier? (b) Derive the saving function for this economy. (c) What is the equilibrium level of output in this economy (use two ways of calculation)? the equilibrium level of consumption? the equilibrium level of savin (AE - Y) space and (injections-leakages) space. g? Draw the graphs in the (d Suppose households increase their autonomous saving by $10 What would be the new consumption function? the new saving function? the amount of autonomous spending? the value of the spending multiplier? the new equilibrium level of output? the new level of consumption? the new level of saving? Redraw the graphs from point (c) and show the changes on both graphs. (e) Now suppose households leave autonomous saving unchanged, but begin to save 25 cents from each additional dollar of income. What would be the new consumption function? the new saving function? the amount of autonomous spending? the value of the spending multiplier? the new equilibrium level of output? the new level of consumption? the new level of saving? Redraw the graphs from point (c) and show the changes on both graphs c How the phenomena, described in points (d) and (e), is called? Explain why. What are the conditions for this phenomenon to take place? Under what conditions can it disappear? (g) Suppose that in the initial situation firms begin to reinvest part of their profits worth 10% of national income. what would be the equilibrium level of output in this case? the equilibrium level of saving? the equilibrium level of investment? Draw the new pair of graphs from point (c) and show the changes on both graphs (h) Now suppose that in the situation, described in point (g). autonomous saving increases by $10. Calculate the new equilibrium levels of output, saving and investment. What happens to the "paradox of thrift" in the presence of the induced investment? Explain your answer. Redraw the resulting graphs from point (g) and show the changes.

Explanation / Answer

(a) autonomous level of spending: $50

as,Investment Spending(I)=$50

Since, no Government Spending and Net Exports

Now, autonomous spending multiplier:

Here, MPC=0.8

as, consumption function: C=$90+0.8YD

Autonomous spending multiplier: 1/(1-MPC)= 1/(1-0.8)= 5

(b) Autonomous saving function:

S=Y-C (C = Autonomous consumption,Y = Income)

S=Y-(90+0.8Y)

S= -90(1-0.8)Y

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