Question

In: Economics

Assume that when an economy has a GDP of $500, Consumption is $550. The MPC is...

Assume that when an economy has a GDP of $500, Consumption is $550. The MPC is .75. Investment is 25. Government Spending equals $50. Begin the problem by completing Income/Consumption Schedule:

                                GDP=DI       Consumption     Investment     Government

                                  $500                  $550                    $25                   $50

                                    600                 

                                    700

                                    800

                                    900

                                  1000

                                  1100

  1. Graph the Consumption Function.
  2. Add Investment to the graph.
  3. Add Government Spending to the graph.
  4. What is the multiplier? (Use the formula discussed in your text.)
  5. What is the Break-Even level of Income? (Do not include Investment or Government Spending)
  6. What is the Equilibrium level of Income? (Include Investment and Government Spending)
  7. What would be the new equilibrium in this economy if Investment increased by $12?

Solutions

Expert Solution

MPC= 0.75

MPC= Change in consumption/Change in GDP

Each time change in GDP= 100

0.75 x 100= Change in consumption

Change in consumption= 75

GDP=DI Consumption Investment Government
500 550 25 50
600 550+75= 625 25 50
700 625+75= 700 25 50
800 700+75= 775 25 50
900 775+75= 850 25 50
1000 850+75= 925 25 50
1100 925+75= 1000 25 50

Graph the Consumption Function:

Add Investment to the graph:

Add Government Spending to the graph:

Multiplier= 1/(1-MPC)= 1/(1-0.75)= 1/0.25= 4

Break-even level of income means the level of income at which it is equals to consumption. According to the table:

GDP=Consumption=700 Break even level of income

Equilibrium level of income arises where:

GDP= Aggregate expenditure

Aggregate expenditure= Consumption + Investment+Government

GDP=DI Consumption Investment Government Aggregate expenditure
500 550 25 50 625
600 550+75= 625 25 50 700
700 625+75= 700 25 50 775
800 700+75= 775 25 50 850
900 775+75= 850 25 50 925
1000 850+75= 925 25 50 1000
1100 925+75= 1000 25 50 1075

Equilibrium level of income is 1000 because aggregate expenditure is also equals to it.

if Investment increased by $12, then new investment= 37:

According to the multiplier:

Multiplier= Change in income / Change in investment

4= Change in income / 12

Change in income = 48

New equilibrium level of income= 1000+48= 1048


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