Question

Consumption = C,   Taxes = T,   Investment Demand = ID, Disposable Income = Y-T, Govt. Purchases of Goods and Services = G Aggregate Expenditure = AE, the MPC is constant, Foreign trade is zero. In case you care, autonomous consumption = $40.

AS = Y	T	Y-T	C	ID	G	AE	d(Inventories)
$9,500	$200		$8,875	$285	$400
$9.900	$200		$9,255	$285	$400
$10,300	$200			$285	$400
$10,700	$200			$285	$400
$11,100	$200			$285	$400
$11,500	$200			$285	$400
$11,900	$200			$285	$400

a. How much of a change in taxes would be needed to raise equilibrium aggregate expenditure by $1,200?

b.  For the previous problem, how much of that rise in equilibrium income would be the result of induced consumption?

c.  Investment Demand falls by $50 and taxes are reduced by $100. What is the change in total equilibrium output?

Answer 1

The table is completed using the following results:

• 
• C=40+0.95(Y-T)
• AE=C+ID+G
• d(Inventories)=Y-AE

AS=Y	T	Y-T	C	ID	G	AE	d(Inventories)
9500	200	9300	8875	285	400	9560	-60
9900	200	9700	9255	285	400	9940	-40
10300	200	10100	9635	285	400	10320	-20
10700	200	10500	10015	285	400	10700	0
11100	200	10900	10395	285	400	11080	20
11500	200	11300	10775	285	400	11460	40
11900	200	11700	11155	285	400	11840	60

a)

The number of expenditure changes by each unit change in taxes is given by tax multiplier. The tax multiplier is calculated as

Then to increase AE by 1200, the decrease in taxes must be

=============================================================

b)

The induced consumption is the part of the consumption that depends on the disposable income. As taxes changes disposable income from very first round, all the increase in expenditure is due to increase in induced consumption. Therefore, the rises in AE due to rise in induced C is $1200.

==============================================================

c)

The expenditure multiplier of this economy is given as

The tax multiplier is -19 and the expenditure multiplier is 20. Therefore any increase in ID and T is given as