Suppose in a hypothetical economy C = 50 + 0·8 Yd, I= 70, G= 200, TR= 100, t = 0·2 (a) Calculate (i) Equilibrium level of Y and multiplier (ii) Budget surplus. b) Suppose t increases to 0·25. What is the new equilibrium income and multiplier? (c) Calculate the change in budget surplus. (d) Explain why the multiplier is 1 when t = 1.
Answers
Answer:
Explanation:
a) Equilibrium level of income is reached when Y = AE and since AE = C + I when
there is no govrnment sector, then:
AE = C + I = 100 + 0.8Y + 50 = 150 + 0.8Y
and then setting the equilibrium Y = AE = 150 + 0.8Y
0.2Y = 150 and Ye = 750
b) We can find S from the identity of C + S = YD (but YD is equal to Y when these
no government sector due to absence of T and TR).
Then C + S = Y and S = Y – C = Y – (100 + 0.8Y) = −100 + 0.2Y
and since Ye = 750, we find that S = −100 + 0.2(750) = 50
c) Involuntary inventory investment = Y – AE = 800 – (150 + 0.8(800)) = 10
Involuntary inventory investment (unsold goods or stocks) increases by 10.
d) İf I increases to 100 (meaning ∆I = +50), then we can calculate the solution either
resolving the equation with the new value of I or using the multiplier.
Y = AE = C + I = 100 + 0.8Y + 100 = 200 + 0.8Y
0.2Y = 200 and Ye = 1000 (or Ye = (1/0.2).200 =1000) hence ∆Y = 1000 – 750
=250.... here (1/0.2) is equal to multiplier (α) = 5 or from the formula α = 1/(1-
MPC) =1/(1-0.8) = 5
Then ∆Y = α.∆I and ∆Y = 5.(+50) = 250 (same result)
e) We found above that the multiplier (α) is equal to 5
f) This is very easy to draw but not here. Please ask me if you have any difficulty