Question

Assume the following information for an economy:

Natural level of output = $190b

Autonomous consumption = 50

Total investment = 16

Government expenditure = 19

Autonomous taxation = 20

Marginal propensity to consume = 0.6

Based on this information answer the following questions:

a) Calculate the actual equilibrium level of output for this economy.

b) Calculate the output ratio for the economy.

c) Using the Phillips Curve illustrate the current approximate position for the economy and identify this as point A.

d) Assume the government increased spending by $5b. Calculate what the new equilibrium level of output will be.

e) As a result of d) indicate how this will likely impact the economy using the Phillips Curve model from c). Label the new position the economy will approximately be at as point B.

f) Discuss whether the government actions in d) are consistent with the objectives of economic stablisation. Include within your discussion reference to what the goals and objectives of economic stabilisation entail.

At the end of your answer to Part 7 state the word count for sub-part f. Your answer to Part 7 sub-part f should not exceed 100 words.

(1 mark each for sub-parts a and b, 1.75 marks for sub-part c, 1.5 marks for sub-part d, 0.75 marks for sub-part e and 2 marks for sub-part f plus 0.25 marks for satisfying the word count requirements - Part 7 worth 8.25 marks)

Answer 1

a) We are provided with the following informations

Natural level of output (Y) = $190b

Autonomous consumption (a) = 50

Total investment (I) = 16

Government expenditure(G) = 19

Autonomous taxation (T) = 20

Marginal propensity to consume (b) = 0.6

The equilibrium level of output is ovtained by the equation:

Y= C(Y- T) +I +G

Y= a +b(Y-T) +I +G

Y= 50 +0.6(Y -20) +16+19

Y= 85 +0.6Y -12

0.4Y= 73

Y= 182.5

The equilibrium level of the economy is Y= 182.5

b) The output ratio of the economy is the ratio of investment to output = 16/182.5= 0.08

c) The phillips cuve illustrated the inverse relationship between inflation and unemployment rate. It cuts the horizontal axis at the natural rate of unemplyment. Here it would cut the horizontl axis at 190. As the economy's equilibrium income is now Y= 182.5, it is producing below the natural rate of unemployment. The point where now th economy is in is marked as pony A.

d) The government spending increased by 5db.

The new governemt spending is (19+5) =24

Th equilirbium equation becomes

Y= 50 +0.6(Y -20) +16+24

Y= 90+ 0.6Y -12

Y= 78 +0.6Y

Y= 78/0.4 =195

The new equilibrium income is 195.