Question

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              $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 Line of Equilibrium (GDP=DI).

Add an Investment + Consumption line to the graph.

Add a Government Spending + Investment + Consumption line to the graph.

What is the multiplier? (Use the formula discussed in your text.)

What is the Break-Even level of Income? (Do not include Investment or Government Spending)

What is the Equilibrium level of Income? (Include Investment and Government Spending)

Answer 1

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

Graph the Consumption Function Line of Equilibrium (GDP=DI).

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(2)

Add an Investment + Consumption line to the graph.

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(3)

Add a Government Spending + Investment + Consumption line to the graph.

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(4) MPC = 0.25

Multiplier = 1 / (1-MPC)

=> Multiplier = 1 / (1- 0.75)

=> Multiplier = 1 / 0.25

=> Multiplier = 4

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(5) At break even level of income, GDP = Consumption.

or, GDP line and consumption line intersects each other.

=> GDP = Consumption = 700 at income level of 700

Hence, the break even level of income is 700

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(6) At equilibrium level of income; GDP = Consumption + Investment + Government

or, GDP line and consumption + investment + government line intersects ecah other.

=> GDP = Consumption + Investment + Government = 1000

Hence, the equilibrium level of income is 1000