Question

From the following data, construct an expenditure schedule on a piece of graph paper. Then use the income-expenditure (45° line) diagram to determine the equilibrium level of GDP.

Income            Consumption                     Investment      Government Purchases           Net Exports

$3,600           $3,280                      $180                        $120                         $40

3,700             3,340                        210                             120                             40

3,800             3,400                         240                             120                             40

3,900             3,460                         270                             120                             40

4,000             3,520                         300                             120                             40

Now suppose investment spending rises to $260, and the price level is fixed. By how much will equilibrium GDP increase? Derive the answer both numerically and graphically.

Answer 1

Aggregate expenditure(AE)= Consumption+Investment+Government purchases+Net exports.

Income            Consumption         Investment      Government Purchases      Net Exports AE

$3,600           $3,280                      $180 120 40 3620

3,700             3,340                        210                             120                             40 3710

3,800             3,400                         240                             120                             40 3800

3,900             3,460                         270                             120                             40 3890

4,000             3,520                         300                             120                             40 3980

Equilibrium level of income is 3800

If investment increases to 260 from 240 then change in GDP=?

Multiplier= 1/(1-MPC)

MPC= Change in Consumption/Change in income= (3340-3280)/(3700-3600)= 60/100= 0.6

Multiplier= 1/(1-0.6)= 1/0.4= 2.5

Another formula for multiplier:

Multiplier= Change in GDP / Cange in investment

2.5= Change in income/(260-240)

2.5 x 20= Change in GDP

Change in GDP= 50

New equilibrium level of GDP= Old equlibrium GDP+Change in GDP= 3800+50= 3850