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Chapter 21: Q 21. (page 567)

If the consumption function is C = 100 + 0.75YD, I = 200, government spending is 200, and net exports are zero, what will be the equilibrium level of output?

What will happen to aggregate output if government spending rises by 100?

Short Answer

Expert verified

Equilibrium level of output = 2000

With Increase in government spending, equilibrium level of output = 2400

Step by step solution

01

Equilibrium Concept 

Economy is at equilibrium, where aggregate demand is equal to aggregate supply.

Aggregate Demand is the total value of output - that sectors of economy (firms, households, government, rest of the world) are planning to buy, at level of income & period of time.

AD = Consumption + Investment + Government Expenditure + Net Exports

Aggregate Supply is the total value of output - all producers of economy are planning to sell, at level of income & period of time. AS value IS equal to National Income

02

Numerical Solution 

  • AD = C + I + G + NX

= 100 + 0.75Y + 200 + 200 + 0

AD = 500 + 0.75Y

  • AS = Y

So,Equilibrium is at where -

AD = Y

500 + 0.75Y = Y

Y - 0.75Y = 500

0.25Y = 500

Y = 500 / 0.25

Y = 2000

03

Change in Government Spending 

G' = New Government Expenditure = 200 + 100 = 300

New AD = C + I + G' + Nx

New AD = 100 + 0.75Y + 200 + (200 + 100) + 0

AD = 600 + 0.75Y

  • New Equilibrium

New AD = Y

600 + 0.75Y = Y

600 = Y - 0.75Y

600 = 0.25Y

Y = 600 / 0.25

Y = 2400

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Most popular questions from this chapter

Consider an economy described by the following data:

C=\(3.25trillionI=\)1.3trillionG=\(3.5trillionT=\)3.0trillionNX=-\(1.0trillionf=1

mpc = 0.75

d = 0.3

x = 0.1

a. Derive simplified expressions for the consumption function, the investment function, and the net export function.

b. Derive an expression for the IS curve.

c. If the real interest rate is r = 2, what is equilibrium output? If r = 5, what is equilibrium output?

d. Draw a graph of the IS curve showing the answers from part (c) above.

e. If government purchases increase to \)4.2 trillion, what will happen to equilibrium output at r = 2? What will happen to equilibrium output at r = 5? Show the effect of the increase in government purchases in your graph from part (d).

Go to http://www.eurmacro.unisg.ch/Tutor/islm.html. Set the policy instruments to G = 80, t = 0.20, c = 0.75, and b = 40. Now increase the sensitivity of investment

to the interest rate, b, from 40 to 80. What happens to the slope of the IS curve? Why

Calculate the value of the consumption function at each level of income in the following table if autonomous consumption = 300, taxes = 200, and mpc = 0.9.

Suppose you read that prospects for stronger future economic growth have led the dollar to strengthen and stock prices to increase.

a. What effect does the strengthened dollar have on the IS curve?

b. What effect does the increase in stock prices have on the IS curve?

c. What is the combined effect of these two events on the IS curve?

During and in the aftermath of the financial crisis of 2007鈥�2009, planned investment fell substantially despite significant decreases in the real interest rate.

What factors related to the planned investment function could explain this?
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