ASSUME THAT THE CONSUMPTION SCHEDULE FOR A PRIVATE OPEN ECONOMY IS SUCH THAT CON

Question

ASSUME THAT THE CONSUMPTION SCHEDULE FOR A PRIVATE OPEN ECONOMY IS SUCH THAT CONSUMPTION C = 50 + 0.8Y. ASSUME FURTHER THAT PLANNED INVESTMENT Ig AND NET EXPROTS Xn ARE INDEPENDENT OF THE LEVEL OF REAL GDP AND CONSTANT AT Ig = 30 AND Xn = 10. RECALL ALSO THAT, IN EQUILIBRIUM, THE REAL OUTPUT PRODUCED (Y) IS EQUAL TO AGGREGATE EXPENDITURES: Y = C + Ig + Xn.
A. CALCULATE THE EQUILIBRIUM LEVEL OF INCOME OR REAL GDP FOR THIS ECONOMY.
B. WHAT HAPPENS TO EQUILIBRIUM Y IF Ig CHANGES TO 10? WHAT DOES THIS OUTCOME REVEAL ABOUT THE SIZE OF THE MULTIPLIER?

Explanation / Answer

1. substitute c into the equation along with the other variables Y=C+Ig+Xn Y = 50+0.8Y + 30 +10 Y = 90 + 0.8Y Y(1-0.8) = 90 Y = 90/0.2 = 450 2. If Ig changes to 10, the 90 in the numerator goes down to 70 i.e. Y = 350 and the whole thing goes down by 20/0.2 = 100. the size of the multiplier changes whatever is on top by 5 times (i.e. 1/0.2 = 5)

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