16. Using the Keynesian Theory show the equilibrium level of price, output and e

Question

16. Using the Keynesian Theory show the equilibrium level of price,

output and employment in the Keynesian theory below the full employment

level.

(a) Assuming that the economy is at equilibrium below the full

employment level of national income show how an increase in government

spending can increase employment.

(b) If the Marginal Propensity to Consume is equal to .5 determine

the change in national income if the government budget calls for $10

billion in additional spending. Assume that $5 billion will be financed

by a tax increase and the remainder will be financed from the sale of

government treasury bills.

Explanation / Answer

a) Since economy is operating below the full employment. If govt increases the spending, it will leads to more demand in the economy. More demand is an indication to producer to start producing more commodities. When production activities pick up, automatically more people are employed.

b.)

Investment multiplier = 1/ 1-MPC

Balanced budget multiplier = 1

Increase in income for 5 billion investment which is financed through treasury bond = (1/1-0.5) *5

=2*5

= 10 Billion

Another 5 billion which is financed through the tax = 1*5

= 5 billion

Total increase in income = 10Billion +5 Billion

=15 Billion

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