Question

In: Economics

Given the following data for a hypothetical closed economy: Real GDP (GDP = Y) Taxes Yd...

Given the following data for a hypothetical closed economy:

Real GDP

(GDP = Y)

Taxes

Yd

C

S

I

G

AE

200

50

190

80

50

250

50

220

80

50

300

50

250

80

50

350

50

280

80

50

400

50

310

80

50

450

50

340

80

50

500

50

370

80

50

550

50

400

80

50

600

50

430

80

50

650

50

460

80

50

700

50

490

80

50

  1. Fill-in the table.

  1. Determine the Breakeven for the economy.

  1. Determine the equilibrium GDP for the economy.
  1. Calculate the expenditure multiplier.
  1. Now suppose that the potential GDP equals 440, by how much should the government purchases or tax change to reach the potential GDP.
  1. Drive consumption or saving equations. (show your work)

Solutions

Expert Solution

(I)

  • Yd = Y - T
  • S = Y - C
  • AE = C + I + G
Y T Yd C S I G AE
200 50 150 190 10 80 50 320
250 50 200 220 30 80 50 350
300 50 250 250 50 80 50 380
350 50 300 280 70 80 50 410
400 50 350 310 90 80 50 440
450 50 400 340 110 80 50 470
500 50 450 370 130 80 50 500
550 50 500 400 150 80 50 530
600 50 550 430 170 80 50 560
650 50 600 460 190 80 50 590
700 50 650 490 210 80 50 620

(II)

In breakeven, Y = AE = 500

(III)

Equilibrium GDP = 500

(IV)

Spending Multiplier = Change in Y / Change in AE = (250 - 200) / (350 - 320) = 500 / 300 = 5/3 = 1.67

(V)

MPC = Change in C / Change in Y = (220 - 190) / (250 - 200) = 30/50 = 0.6

Tax multiplier = - MPC / (1 - MPC) = - 0.6/0.4 = - 1.5

Positive output gap = Equilibrium Y - Potential G = 500 - 440 = 60

Required decrease in G = Positive output gap / Spending multiplier = 60 / (5/3) = 36

Required increase in T = Positive output gap / Tax multiplier = 60 / 1.5 = 40

(VI)

(a) Consumption: C = a + bY

190 = a + 200b..............(1)

220 = a + 250b..............(2)

(2) - (1) yields:

50b = 30

b = 0.6

a = 190 - 200b [from (1)] = 190 - (200 x 0.6) = 190 - 120 = 70

Therefore,

C = 70 + 0.6Y

(b) Saving: S = Y - C

S = Y - 70 - 0.6Y

S = - 60 + 0.4Y


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