Question

2) Given the following

C = 25 + 0.8Yd I* = 100

and assuming fixed prices

1. a) What is the equilibrium level of NP ?
2. b) What is the equilibrium level of savings ?
3. c) What is the value of the multiplier ?
4. d) If planned investment falls 10, ceteris paribus, what is the new level of equilibrium NP ?
5. e) If the MPC increases to 0.85 what would equilibrium NP be with I*= 100 ?
6. f) If the MPS falls to 0.10 what would equilibrium NP be with I*= 100 ?

3) Given the following information;

C = 40 + 0.8Yd
I* = 50
and assuming fixed prices

1. a) What is equilibrium NP ?
2. b) If desired investment increases 25 what is the new equilibrium level of NP ?
3. c) What is the new equilibrium level of savings ?

d) What is the new equilibrium level of consumption?

Answer 1

Solution-2

Given that -

Consumption Function: C = 25 + .8Y_d

Investment : I* = 100

We assume that it’s a closed economy. So we have

Government expenditure: G = 0

Tax rate : t= 0

Thus, we can rewrite consumption function as

C = 25 + .8(Y-tY) = 25 + .8Y

C = 25 + .8Y

a)

At equilibrium, Y = C+I+G

Substituting values we get,

Y = 25 + .8Y + 100 + 0

Y = 125 + .8Y

Y- 0.8Y = 125 = 0.2Y = 125

or Y = 625

Thus, the equilibrium level of income is 625 .

B)

At equilibrium,

Savings = Investment

S = I

we have I* = 100 so S* = 100

Thus, the equilibrium level of saving is 100 .

c)

In closed economy, the value of multiplier is given by the following formula -

Multiplier = 1/ ( 1- MPC)

we have MPC = .8

so Multiplier = 1 / (1-.8) = 1/ 0.2 = 5

Thus, the value of multiplier is 5.

​​​​​​​d)

Given investment falls by 10 so we have I* = 90

using the formulations as in part (a), we have

At equilibrium, Y = C+I+G

Substituting values we get,

Y = 25 + .8Y + 90 + 0

Y = 115+ .8Y

Y- 0.8Y = 115 = 0.2Y = 115

or Y = 575

Thus, the equilibrium level of income is 575 when planned investments falls to 90.