Consider a closed economy to which the Keynesian cross analysis applies. Consump

Question

Consider a closed economy to which the Keynesian cross analysis applies. Consumption is given by the equation C=200+2/3(Y-T). Planned investment is 300, as are government spending and taxes. If Y is 1,500 what is planned spending? What is inventory accumulation or decumulation? Should equilibrium Y be higher or lower than 1,500? What is equilibrium Y? What are equilibrium consumption, private saving, public saving, and national saving? How much does equilibrium income decrease when G is reduced to 200? What is the multiplier for government spending?

Explanation / Answer

a. If Y is 1,500, what is planned spending? What is inventory accumulation or decumulation? Should equilibrium Y be higher or lower than 1,500? If Y is 1500, Planned spending, E = C+I+G = 200+ 2/3(Y-T)+300+300 = 800 +2/3(1500-300) =800+ 2/3(1200) =800+800 =1600 So, at Y=1500, planned spending is 1600. Since at Y=1500, planned spending (1600) is higher than current output, there will be unplanned inventory decumulation. The amount of inventory decumulation = (E-Y) = (1600-1500) = 100. At Y=1500, firms meet the excess demand by supplying goods from their inventories, resulting into an unplanned reduction in their stock of goods. Firms would respond to this decline in inventories by producing more goods. So, the equilibrium Y must be higher than 1500. ========================= What is the planned expenditure function? What is equilibrium level of income? Show your results in a diagram clearly indicating the intercepts and equilibrium values. The planned expenditure function, E = C+I+G =200 +2/3(Y-T)+300+300 = 800 + 2/3(Y-300) = 800 +2/3Y -200 = 600 + 2/3Y So, the planned expenditure function, E, is 600 +2/3Y If Y is 0, E = 600. So, the vertical intercept (E-intercept) of the expenditure function is 600. The equilibrium condition: Y = E or, Y = 600 +2/3Y or, Y-2/3Y = 600 or, 1/3Y = 600 or, Y = 1800 So, equilibrium level of income is 1800. =========== What are equilibrium consumption, private saving, public saving, and national saving? The equilibrium consumption, C = 200 + 2/3(Y-T) = 200 + 2/3 (1800-300) = 200 + 2/3(1500) = 1200 So, the equilibrium consumption is 1200. The equilibrium private saving, SP = Y-C-T = 1800-1200-300 = 300 So, the equilibrium private saving is 300. The equilibrium public saving, SG = T-G = 300

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