Question

An economy is described by the following equations:

C	= 40 + 0.8 (Y – T)
I	= 70
G	= 120
NX	= 10
T	= 150

a. When Y = 600, aggregate expenditure is .

b. Consumers and businesses alike become more pessimistic about the future and reduce their respective expenditures by 10 each. Immediately following this change, what is aggregate expenditure if Y is still 600? (In other words, what is the initial change in aggregate expenditure?)

The new aggregate expenditure is

In order to offset the initial drops and avoid a recession, government purchases should be change by .

e. If the multiplier effect were allowed to take effect, then government purchases would have to change by .

Answer 1

a) Aggregate Expenditure = C + I + G + NX

C = 40 + 0.8 (Y - T)

Y = 600

T = 150

So, C = 40 + 0.8 (600 - 150)

= 40 + 0.8 * 450

= 40 + 360

= 400

C=400

I = 70

G =120

NX= 10

So, Aggregate Expenditure = 400 +70 + 120 + 10

= 600

Aggregate Expenditure = 600

b) Reducing Consumption and business investment by 10, we get

C = 400 - 10 = 390

I = 70-10= 60

G = 120

NX = 10

So, Aggregate Expenditure = C+ I + G + NX

= 390 + 60 + 120 + 10

= 580

The new aggregate expenditure is 580

In order to offset the initial drops and avoid a recession, government purchases should be changed by 20.

As there is a drop of consumption and investment by 20, the government purchases should increase by 20.

e) If the multiplier effect were allowed to take effect, then government purchases would have to change by .less than 20.

This is because due tomultiplier effect, a small change in government purchases would bring about more change in aggregate expenditure depending on the multiplier.