Given the following variables in the open economy aggregate expenditure model, a

Question

Given the following variables in the open economy

aggregate expenditure model, autonomous

consumption (C0) = 200, autonomous investment

(I0) = 200, government spending (G0) = 100,

export spending (X0) = 100, autonomous import

spending (M0) = 100, taxes (TP) = 0, marginal propensity

to consume (c1) = 0.8, marginal propensity

to invest (i1) = 0.1, and marginal propensity

to import (m1) = 0.15,

a. Calculate the equilibrium level of income for the

open economy aggregate expenditure model.

b. If there is an increase in autonomous import

expenditure from 100 to 200 resulting from an

increase in the currency exchange rate, calculate

the new equilibrium level of income and

the value of the multiplier.

c. Compared with the original equilibrium in part

a, if the government decides to impose taxes

(TP) of 100, calculate the new equilibrium level

of income.

Hint: Remember that consumption has an autonomous

component and is a function of disposable

income, Yd, where Yd = Y – TP.

Explanation / Answer

(a) Ye=2,000
(b) Ye=1,600 and m=4

E=Co+c1+Io+i1y+Go+Xo-Mo-m1Y
E=Co+Io+Go+Xo+Mo+(0.75+0.10-0.25)Y
E = Co + Io + Go + Xo – Mo + (c1 + i1 – m1)Y
E = 200 + 200 + 100 + 100 – 100 + (0.8 + 0.1 – 0.15)Y
E = 500 + 0.75Y
Y = 500 + 0.75Y
Y –i 0.75Y = 500
0.25Y = 500
YE = 2,000

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