Suppose an imaginary economy is represented by the following equations: GDP= C +

Question

Suppose an imaginary economy is represented by the following equations:

GDP= C + I

C= $100 + 0.8 Y D

I = I Planned + I Unplanned

Iplanned = $200

AEplanned = C+IPlanned

(1)    Calculate the income- expenditure equilibrium level GDP. Show your work.

(2)    Suppose the level of planned investment spending (Iplanned) drops by $50 . What will the new equilibrium GDP be? Show your work

(3)    With Iplanned back at the original level $200, suppose that autonomous consumption spending decreases from $100 to $60. What will the new equilibrium be? Show your work.

(4)    Calculate the value of the multiplier.

Explanation / Answer

we know Y = C + S ; at equilibrium S = I ; Y = C + I ; also by keynes consumption function C = a +bY ;

hence using the above Y = 100 + 0.8Y + 200 ; solving we get Y = 1500 ; C = 1300 ;

if Iplanned dropped to 50 ; then Y changes to Y =100+0.8Y + 50 ;Y= 750 ; C= 700 ;

if autonomous consumption decreases to 60 ; Y = 60 +0.8Y + 200 ; Y = 1300; C = 1100 ;

value of multiplier = 1 / MPS = 1/ 1-0.8 = 1/ 0.2 = 5 answer   

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