Question

Answer the following with respect to the graph below: (2 marks each)















a) What is the level of desired investment expenditure (I) and government purchases (G)? b) What is the autonomous portion of consumption? What is total autonomous expenditure? c) Starting from equilibrium national income of $250 billion, suppose government purchases decreased by $25 billion. Describe the effects on the AE curve and on equilibrium national income. d) Starting from equilibrium national income of $250 billion, suppose the net tax rate increased from 10% to 30% of national income. Describe the effects on the AE curve and on equilibrium national income. e) Starting from equilibrium national income of $250 billion, suppose investment increased by $50 billion. Describe the effects on the AE curve and on equilibrium national income.

Answer 1

(a) The overall rate of investment + government expenditure is $100. Investment = 50, governmnet expenditure = 100-50 = 50

(b) $50, is the autnomous consumption level. This is because at zero income autonomous spending is $150, out of which $100 is I+G. $50 is autonomous level of consumption.

(c) When governmnet procurement decreases by $25 billion the AE curve will shift to left. SInce Government expenditure is not based on income level, there will be a corresponding leftward shift. The autonomous expenditure will now be 150-25 = $125 billion. The national income will fall due to fall in government expenditure. The new national income will be where the new AE meets the 45 degree line.

(d) The gradient of the AE curve will change if taxes increase. The AE curve will become steeper as tax is based on income level. The new national income is going to be below $250 billion.

(e) The current autonomous spending will be $200 billion ($150+ 50) if investment rises by $50 million. The AE curve moves to the right, the new national income exceeds $250 billion.