Question

Miniland has its economic structure indicated by the following equations (in billion $):

C = $600 + 0.8 Yd, T = $125 + 0.1 Y G = $400

I = $800

X = $300

M = $80 + 0.22 Y

AE = C + I + G + X – M

where Yd = Y - T

where AE = planned aggregate expenditure, C = consumption expenditure, Yd = disposable income, Y = national output, I = investment, G = government expenditure, T = taxation, X = exports and M = imports.

(a) What are the values of the MPC and MPM of Miniland? If Miniland’s disposable income and GDP increase by $6 billion and $10 billion respectively, how much will its consumption and import be changed?

(b) Calculate Miniland’s income multiplier, equilibrium national income, government budget balance, trade balance and equilibrium consumption spending. Show the steps of your calculation.

(c)

(i) The spreading of the Covid-19 in the world reduces Miniland’s export by $30 billion. How much will the disease affect Miniland’s GDP? Show the steps of your calculation.

(ii) If the government of Miniland wants to restore its GDP to the original level, how

much should the autonomous tax (or lump-sum tax) be changed? Show the steps of your

calculation.

Answer 1

I m solving (b) part before (a) because it is required.

Solution (b):

For calculating equilibrium national income

Y=C+I+G+(X-M)

Y = (600+0.8Yd) + 800 + 400 + (300-80-

0.22Y)

Y= 2020+0.8Yd-0.22Y

Y= 2020+0.8(Y-125-0.1Y)-0.22Y

Y= 2020+0.8(0.9Y-125)-0.22Y

Y=2020+0.72Y-100-0.22Y

Y-0.50Y=1920

0.50Y=1920

Y= 3840 Equilibrium national income

Income Multiplier=1/1-mpc

Income multiplier=1/1-0.8

Income multiplier=5

Equilibrium cons expdt

Y=C+I

3840=C+800

3840-800=C

3040=C

TRADE BALANCE

X-M=300-(80+0.22*3840)

X-M=300-924.8

X-M=(-624.8)

GOVT BUDGET BALANCE

G-T=(S-I)-(X-M)

G-T=624.8

(a)MPC=0.8

MPM=0.22

Where,mpc is marginal propensity to consume which is slope of consumption line.

mpm is marginal propensity of import which is slope of import line.

(C) (i)export decreases by $30 billion,new export=270

Y=C+I+G+(X-M)

Y=3040+800+400+(270-924.8)

Y=4240+(-654.8)

Y=3585.2

(ii)change in Y=3585.2-3840

Change in Y=-254.8

For this Tax multiplier will be calculated:

Tax multiplier= (-mpc)/mps

Tax multiplier = (-0.8)/0.2

Tax multiplier = 4

Tax should be changed by $4 billion