Use the following macroeconomic model to answer the questions from 1 through 12:

Question

Use the following macroeconomic model to answer the questions from 1 through 12: You must show your work of estimation to obtain the credits.   

C = 100 + 0.80Yd; C = consumption function; Yd = disposable income (Y-T)

T = 100; T = Tax revenue

I = 150; I = Investment

G = 200; G = Government expenditure

Yf = Full Employment RGDP (Potential RGDP) = 2600

3. At the equilibrium level of output you estimated for Q1 above, estimate the aggregate saving level.

4. The MPC and MPS for the economy are respectively:

5. The expenditure multiplier for the economy is:

6. The tax multiplier for the economy is:

7. If the Tax amount is reduced from $100 to $50, estimate the equilibrium GDP level (income).

8. With Tax amount keeping at $100, if Government spending (G) is increased from previous level of $200 to $300, estimate the equilibrium level of GDP.

Explanation / Answer

Y = C + I + G + NX

= 100 + 0.80Yd + 150 + 200

Y = 0.8(Y - 100) + 450

0.2Y = 450 - 80 = 370

Y = 1,850

(3) When Y = 1,850,

C = 100 + 0.8(Y - 100) = 100 + 0.8(1,850 - 100) = 100 + 0.8 x 1,750

= 1,500

So, Savings = Y - C = 1,850 - 1,500 = 350

(4)

MPC = 0.80

MPS = 1 - MPC = 1 - 0.8 = 0.2

(5)

Expenditure multiplier = 1 / MPS = 1 / 0.2 = 5

(6)

Tax multiplier = - MPC / MPS = - 0.8 / 0.2 = - 4

(7)

Tax multiplier of -4 means, if Tax is decreased by 1%, GDP increases by 4%.

If Tax decreases by 50% (From $100 to $50), GDP will increase by (4 x 50%) = 200%. That is, Y will treble.

GDP = $1,850 x 3 = $5,550

(8) G increases by $100.

So:

Y = C + I + G + NX

= 100 + 0.80Yd + 150 + 300

Y = 0.8(Y - 100) + 550 = 0.8Y + 470

0.2Y = 470

Y = 2,350

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