Question

Given the following data for a hypothetical closed economy:

Real GDP (GDP = Y)	Taxes	Yd	C	S	I	G	AE
200	50		190		80	50
250	50		220		80	50
300	50		250		80	50
350	50		280		80	50
400	50		310		80	50
450	50		340		80	50
500	50		370		80	50
550	50		400		80	50
600	50		430		80	50
650	50		460		80	50
700	50		490		80	50

1. Fill-in the table.

2. Determine the Breakeven for the economy.

3. Determine the equilibrium GDP for the economy.

4. Calculate the expenditure multiplier.

5. Now suppose that the potential GDP equals 440, by how much should the government purchases or tax change to reach the potential GDP.

6. saving equations. (show your work)

Answer 1

We have completed the table using the formulas:

Y_d = Y-T , S = Y_d-C , AE = C+I+G

i) The break-even point for the economy is attained at the point where C intersects 45⁰ line, i.e, S=0. Here, break-even point is where consumption is 250 and real GDP is 300.

ii) Equilibrium is attained at the point where AE=Real GDP=500.

iii) Expenditure multiplier = 1/(1-mpc) = 1/(1-0.6) = 2.5

{where mpc = change in consumption/change in dispsable income = 30/50 = 0.6}

iv) If potential GDP = 440,

output gap = potential GDP-real GDP

or, output gap = 440-500

or, output gap = -60

In order to close the gap, government must decrease government purchase or increase tax = output gap/multiplier

or, government must decrease government purchase or increase tax = 60/2.5

or, government must decrease government purchase or increase tax = 24.

v) Savings function S = -C+Y_d (where Y_d is the disposable income and C is the consumption)

or, S = -{C₀+0.6(Y-T)}+(Y-T) (where C₀ is the autonomous consumption and T is the tax)

or, S = -C₀+0.4Y

Thus, S = f(Y) (where C₀ is a variable)