Suppose that in your country, the marginal propensity to save equals 15 percent of disposable income,...

Suppose that in your country, the marginal propensity to save equals 15 percent of disposable income, when income is null, consumption of C = 150, government expenditure of G = 100 and fixed taxes = 80, and that investment of I = 50. Calculate the equilibrium level of GDP. Solve for a change in GDP following an increase in expenditure of 20 percent, financed by an increase of taxation of the same amount. What does it tell you about the impact of expenditure that is fully financed by taxation?

Expert Solution

C=150+0.85Yd. G=100. Lumpsum taxes=80. Investment=50

We know at equilibrium Y=Aggregate expenditure=C+I+G

Y= 150+0.85(Y-80)+ 50+100=232+0.85Y

Thus Y=232/0.15=1546.66667

An increase in G and taxes by 20% which means G and taxes both increases by 20 will increase the equilibrium by $20 because balanced budget multiplier=1

Thus equilibrium level.of income will increase by exactly the same amount as Govt expenditure and taxes increases

Rahul Sunny answered 2 years ago

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