Assume that following model of the economy: C = 180 + 0.8 (Y-T), I = 190, G = 25
ID: 1202189 • Letter: A
Question
Assume that following model of the economy: C = 180 + 0.8 (Y-T), I = 190, G = 250, T = 150
1. If government purchases were to increase by 10 to 260, what would happen to each of the following? State the amount as well as the direction of the changes.
(a) The planned expenditure curve
(b) The equilibrium level of income
(c) The level of consumption
(d) The government budget deficit
2. Starting over again at G = 250, suppose that taxes increased by 10 to 160. What would happen to each of the following? State the amount as well as the direction of the changes.
(a) The planned expenditure curve
(b) The equilibrium level of income
(c) The level of consumption
(d) The government budget deficit
3. Start over one last time at G = 250 and T = 150, suppose that government expenditures and taxes were both increased by 10 to 260 and 160, respectively. What would happen to each of the following? This time, draw the consumption, government purchases, and planned expenditure graphs to indicate the amount as well as the direction of the changes.
(a) The planned expenditure curve
(b) The equilibrium level of income
(c) The level of consumption
(d) The government budget deficit
Explanation / Answer
(1)
(a): Planned expenditure curve is:
Y = C + I + G
Y = 180 + 0.8(Y - T) + 190 + 250
Y = 620 + 0.8(Y - 150) = 620 + 0.8Y - 120
Y = 0.8Y + 400
If G increases by 10, the new planned expenditure equation becomes:
Y = 0.8Y + 400 + 10 = 0.8Y + 410
Therefore, vertical intercept of planned expenditure curve increases by 10, and the curve undergoes an upward parallel shift.
(b)
When G = 250, Y = 0.8Y + 400
0.2Y = 400
Y = 2000
When G = 260, Y = 0.8Y + 410
0.2Y = 410
Y = 2050
So, equilibrium income increases by (2050 - 2000) = 50.
(c)
When G = 250, Y = 2000.
C = 180 + 0.8(Y - 150) = 180 + 0.8(2000 - 150) = 180 + 0.8 x 1850 = 180 + 1480 = 1660
When G = 260, Y = 2050
C = 180 + 0.8(Y - 150) = 180 + 0.8(2050 - 150) = 180 + 0.8 x 1900 = 180 + 1520 = 1700
Consumption increases by (1700 - 1660) = 40
(d)
Government budget deficit (BD) = G - T
When G = 250, BD = 250 - 150 = 100
When G = 260, BD = 260 - 150 = 110
So, budget deficit increases by (110 - 100) = 10.
NOTE: First question is answered in full.