In: Economics
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
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