suppose iceland\'s economy has the following components of aggregate demand: C=4

Question

suppose iceland's economy has the following components of aggregate demand:

C=400+0.6*(Y-0.2Y)

I = 500

G = 300

NX = 100 - 0.1Y

A. explain the different numbers in the consumption function

B. calculate the keynesian multiplier, autonomous spending, and the equilibrium level of output.

C. calculate the level of private savings, government savings, and national savings.

D. illustrate your answers to b graphically on a keynesian cross diagram.

E. suppose a boom in investment in Iceland causes investment to increase to I=600. calculate the effect on Iceland's output as a result.

F. explain intuitively the effect on output in iceland's economy as a result of the increase in investment from part e. also illustrate this process on your graph from part d.

Explanation / Answer

A. C= 400 + .48 Y

400= autonomous consumption function.

0.48= induced consumption(marginal prospensity to consume).

Y = disposable income.

B. I= 500

Marginal prospensity to consume = 0.48

therefore Keynesian multiplier = (500 + 500*.48 + 500*.48^2 + .........)/500

= 1/(1-0.48) = 1/0.52 = 25/13.

autonomous spending = 400.   

to calculate equilibrium output:

Y = C+ I

Y= 400 + .48 Y + 500

.52 Y = 900

Y = 900/ 0.52 = 1730.76.

E. If I = 600

For equilibrium output.

  Y = C+ I

Y= 400 + .48 Y + 600

.52 Y = 1000

Y = 1000/ 0.52 = 1923.07

Therefore equilibrium output increases.

F . in general equilibrium output is directly proportional to the I(investment).

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