Question

1. You are provided with the following information:

following equations, with G and X to be determined exogenously:

Y = C+I+G-X-M

Yd= Y-T

T=tY

C= a+bY

I= c+dY-er

IM = m(Y-T)

Use the above model to determine the government expenditure multiplier. Explain the factors that affect the size of the multiplier in the model.

Answer 1

The factors are known as leakages, since they decide how much demand "spills out" in each round of the multiplier impact. On the off chance that the spillages are generally little, at that point each progressive round of the multiplier impact will have bigger amount of demand, and the multiplier will be high. On the other hand, in the event that the leakages are generally huge, at that point any underlying change sought after will decrease all the more rapidly in the second, third, and later rounds, and the multiplier will be little.

Leakages includes:

• Marginal propensity to import.
• Marginal propensity to save.
• Tax rate.

Any change in the size of the leakages will lead to change the size of the multiplier.