Assume the following data for this economy. Full employment GDP occurs at $400.
ID: 1154230 • Letter: A
Question
Assume the following data for this economy. Full employment GDP occurs at $400. Assume that the MPC = 0.75. All figures are in billions of dollars.
GDP C S I G
240 244 -4 8 8
260 260 0 8 8
280 276 4 8 8
300 292 8 8 8
320 308 12 8 8
340 324 16 8 8
360 340 20 8 8
380 356 24 8 8
400 372 28 8 8
1. Equilibrium GDP for this economy is ___________.
2. What is the problem facing this economy? _____________________
3. What general solution do you recommend? ____________________
4. The simple multiplier in this problem is equal to __________________.
5. What is the needed change in government spending: ________________
Explanation / Answer
The equilibrium GDP for the economy is 340. This comes from the fact that equilibrium GDP is the sum of consumption + investment + government expenditure. When the GDP is 340 this sum is also equal to (324+8+8)=340. Therefore the equilibrium GDP is 340.
Because the full employment GDP is 400, current GDP is less than full employment GDP so that there is a recessionary gap in the economy.
A general solution to this problem is that the aggregate demand should be increased this can be done by increasing the government expenditure reducing the taxes or by increasing the money supply.
Simple multiplier is the reciprocal of the marginal propensity to save. Because the marginal propensity to consume is 0.75 the marginal propensity to save is 0.25. its reciprocal is 4 so that the multiplier in the economy is 4.
Because the recessionary gap is the difference between 400 and 340 which is 60, an increase in the government spending by 60/4 = 15 will be required to close the recessionary gap. Hence the needed change in government spending is 15.
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