Question

Include correctly labeled diagrams, if useful or required, in explaining your answers. A correctly labeled diagram must have all axes and curves clearly labeled and must show directional changes. If the question prompts you to “Calculate,” you must show how you arrived at your final answer.

The table below provides data on the spending on final goods, in billions of dollars, by consumers, businesses, and the government in equilibrium in a country with no international trade.

Aggregate Variables	Value (in Billions of Dollars) in the Base Year
Consumption spending	$900
Investment spending	$400
Government spending	$200
Transfer payments	$60

The marginal propensity to save is equal to 0.40 and there are no exports or imports.

(a) Calculate the real GDP in this country. Show your work.

(b) Calculate the marginal propensity to consume. Show your work.

(c) Suppose that the government increases spending from $200 billion to $300 billion.

(i) Calculate the maximum change in real GDP. Show your work.

(ii) Given the change in real GDP in part (c)(i), calculate the maximum level of the new equilibrium real GDP. Show your work.

(d) Suppose that taxes decrease by $100 billion. Will the maximum change in real GDP be larger than, smaller than, or equal to the change in real GDP identified in part (c)(i) ? Explain.

Answer 1

A) we can calculate GDP by expenditure method

GDP at mp= C+G+I+X-M

but there is no export import so

GDP at mp=C+G+I

GDP at mp =900+400+200=1500 billion dollars

B) we know that MPC+ MPS=1

MPS=.40

SO MPS +MPC=1

.40+MPC=1

MPC=1-.40=.60

C) WE KNOW THE FORMULA OF GOVERNMENT MULTIPLIER

ΔY=1/(1-MPC) *ΔG

MPC=.60

ΔG=300-200=100

ΔY=1/1-.60 *100

ΔY=1/.40 *100

ΔY=100/40 *100

ΔY=50/20 *100

ΔY=2.5*100 =250

SO REAL INCOME WILL BE INCREASED BY 250 BILLION DOLLARS( WHEN GOVERNEMENT INCOME IS INCREASED FROM 300 TO 200 BILLION DOLLARS)

D) TAX MULTIPLIER FORMULA WHEN TAX IS REDUCED =b/1-b *Δt

b=MPC=.60