Question

1. Consider the following equations that describe a closed economy with no government. Assume consumption is represented by the following: C = 200 + 0.9Y. Also assume that planned investment (I) equals 300.
   1. Obtain the saving function for this economy. What are the marginal propensity to save (MPS) and marginal propensity to consume (MPC)?
   2. Write the equation for the planned aggregate expenditure.
   3. Find the equilibrium level of output and calculate the level of consumption and saving that occurs at the equilibrium level of income.
   4. Explain the saving-investment approach to equilibrium. Recalculate the equilibrium level of output of the economy by saving-investment approach.
   5. Calculate the multiplier for this economy. Verbally explain the meaning of the calculated multiplier figure.
   6. Now, suppose the level of income is equal to 4000. What is the level of planned aggregate expenditures at this level of income? What is the value of any unplanned changes in inventories?
   7. Assume that investment increases by 25%. Using multiplier calculate the new equilibrium.

Answer 1

ans

a) C = 200 + 0.9Y

200 is autonomous consumption C1

0.9 is MPC, marginal propensity to consume,c

marginal propensity to save, s=MPS= 1- MPC= 1-0.9=0.1

saving function is given by

S= -C1 + s(Y) = -200 + 0.1Y

S= -200 + 0.1Y

0.9 is MPC, marginal propensity to consume,c

marginal propensity to save, s=MPS= 1- MPC= 1-0.9=0.1

b) planned aggregate expenditure

AE =C+I

I is investment

AE= 200 + 0.9Y +300

AE= 500+ 0.9Y

ans c)

equilibriumis determined where

Y= AE

Y= 500+ 0.9Y

0.1Y= 500

Y= 5000 is equilibrium level of income

C = 200 + 0.9Y

at equilibrium

C= 200+ 0.9*5000 = 4700

S= -200 + 0.1Y

at equilibrium

S= -200 + 0.1*5000 = 300

d)

according saving investment approach, at equilibrium

S= I

-200 + 0.1Y = 300

0.1Y= 500

Y= 500/0.1

Y=5000 is equilibriumm acc to saving - investment approach

e)

multiplier= 1/ mps = 1/(1-mpc)

multiplier= 1/0.1 =10

multiplier=

which means if investment increases by 1, income will increase by 10, that's why multiplier is 10

f) if income is 4000

AE = 500+ 0.9Y

=500 + 0.9*4000 = 4100

so here AE> Y

here unplanned inventories will fall by 100 ( diiference between AE- Y) because demand is more than supply

g) if investment increases by 25%, which means investment will increase by 25% of 300 = 75

so according to multipler

m=

= 10

new equilibrium =