1. Consider an economy in which autonomous consumption is 800, the marginal prop
ID: 1200404 • Letter: 1
Question
1. Consider an economy in which autonomous consumption is 800, the marginal propensity to consume is 0.8, investment is 400, government spending is 500, taxation is 400, and net exports are 100.
A. What is the equilibrium GDP in this economy? Show your work. (3 points)
B. What is the savings at this level of GDP? Show your work. (3 points)
C. What are the spending and tax multipliers? Show your work. (4 points)
D. If government spending increases by 200, what is the new equilibrium GDP and what is the increase over the original equilibrium GDP? Show your work. (4 points)
E. If the government increases both spending and taxation by 200, what is the new equilibrium GDP and what is the increase over the original equilibrium GDP? Show your work. (4 points)
Explanation / Answer
1. A. GDP = C + I + G + (N – X)
GDP = $800 + $400 + $500 + $100
GDP in this economy = $1,800.
Savings: 1 - MPC
MPC = 0.8 is $800
Then 1 = 1 / 0.8 x 800 = $1,000
Savings = $1000 - $800 = $200.
B. Spending multiplier:
Spending multiplier = 1 / MPS (marginal propensity to save)
Spending multiplier = 1 / (1 – MPC) = 1 / (1 – 0.8) = 1 / 0.2 = 5.
C. Tax multiplier:
Tax multiplier = MPC / MPS
Tax multiplier = MPC / (1 – MPC)
Tax multiplier + 0.8 / 0.2 = 4.
D. If the government increases spending by 200, the new equilibrium would be:
GDP + 200 = $1,800 + 200 = $2,000 (new equilibrium)
Percentage increase in GDP level = 200 / 1800 x 100 = 11.11% (over the old GDP)
E. If government increases both spending and taxes:
GDP = C(800-200) + I + G(+200) + NX
GDP = 600 + 400 + (500 + 200) + 100
GDP = .600 + 400 + 700 + 100
GDP = 1, 800.
As a result, there is no change in old equilibrium level of GDP.
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