Question

In: Economics

Components RM (million) Autonomous Consumption (Co) 55 Investment (I) 165 government expenditure (G) 195 Personal Income...

Components

RM (million)

Autonomous Consumption (Co)

55

Investment (I)

165

government expenditure (G)

195

Personal Income Taxes (T)

255

Net Export (NX)

0

Using information in the table above, given the marginal propensity to consume (MPC) is 80%, find the following;

  1. Derive the consumption function.

  1. Derive the saving function.

  1. Derive the total expenditure (TE) curve.

  1. Draw the aggregate expenditure curve.

  1. What is equilibrium real GDP for Keynesian Island?

If the government increases its purchases by RM 200 million, what will be the new equilibrium real GDP? [Hint: Show your computation using multiplier

Solutions

Expert Solution

(a) Consumption function: C = Co + MPC (YD)

Where, Co is autonomous consumption. Autonomous consumption is the level of consumption at zero level of output.

YD is disposable income.

YD = Y - T

=> C = 55 + 0.8YD

consumption is measured in RM million

-------------------------------------------------------------------------------------------------

(b) Saving function: S = So + MPS (YD)

So is the saving at zero level of income. It is equal to negative of autonomous consumption.

=> So = -55

MPC + MPS = 1

=> MPS = 1 - MPC

=> MPS = 1 - 0.8

=> MPS = 0.2

S = -55 + 0.2YD.

Saving is measured in RM million

-------------------------------------------------------------------------------------------------

(c) TE = C + I + G + NX

=> TE = 55 + 0.8(YD) + 165 + 195 + 0

=> TE = 415 + 0.8(Y - T)

=> TE = 415 + 0.8(Y - 255)

=> TE = 415 + 0.8Y - 204

=> TE = 211 + 0.8Y

Note: TE and aggregate expenditure are same.

TE is measured in RM million

-------------------------------------------------------------------------------------------------

(d) TE =AE = 211 + 0.8Y

Note: TE = aggregate expenditure

-------------------------------------------------------------------------------------------------

(e) At equilirium; Y = AE

=> Y = 211 + 0.8Y

=> Y - 0.8Y = 211

=> 0.2Y = 211

=> Y = 211/0.2

=> Y = 1055

Equilirium real GDP is RM1055 million.

-------------------------------------------------------------------------------------------------

(f) MPC = 0.8

Government spending multiplire = 1 / (1-MPC)

Government spending multiplire = 1/ (1 - 0.8)

Government spending multiplire = 5

Government spending increases by RM 200 million.

----------------------

Government spending multiplier = (change in real GDP / change in government spending)

=> 5 = (chnage in real GDP / RM 200 million)

=> Change in real GDP = 5 * RM 200 million

=> Change in real GDP = RM 1000 million

Hence. the real GDP will rise by RM 1000 million.

Rahul Sunny answered 2 years ago
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