Economics 201
Week 9 Assignment
Dr. Neri
1. Consider an economy in which tax collections are always $400 and in which the four
components of aggregate demand are as follows:
GDP
1360
1480
1600
1720
1840
Taxes
400
400
400
400
400
Disp Income
960
1080
1200
1320
1440
C
720
810
900
990
1080
I
230
230
230
230
230
G
400
400
400
400
400
NX
100
100
100
100
100
1720
a. What is the equilibrium level of GDP?
Answer: Y = 1720
What is the marginal propensity to consume?
Answer: MPC = 0.75
b. What is the multiplier for government spending (∆ Y / ∆ G)?
Answer: (∆ Y / ∆ G) = 1/(1-MPC) = 4.0.
c. Determine the new equilibrium level of GDP if government purchases were reduced by $60?
Answer: (∆ Y) = 1/(1-MPC) x ∆ G = 4 x -60 = -240
New equilibrium Y = 1720 - 240 = 1480
2. Bernankistan is a small country ruled by Sir Alan of Greenspan.
You are given the following information about the economy:
C = 75 + 0.6Yd
I = 125
G = 81
T = 81 ( Lump-Sum)
Yd = Y – T
Bernankystan does not have Imports (M) or Exports (X).
a. Solve for the equilibrium level of income.
Answer: Y = 581. Substitute and solve.
b. Calculate the government spending multiplier (∆ Y / ∆ G).
Answer: (∆ Y / ∆ G) = 1/(1-MPC) = 2.5
c. Calculate the investment spending multiplier (∆ Y / ∆ I).
Answer:
(∆ Y / ∆ I) = 2.5, the same as the spending multiplier
d. Sir Alan wants to increase government spending by 8 from 81 to 89. What will happen to the
equilibrium income? Solve for the new equilibrium level of income?
(∆ Y) = 1/(1-MPC) x ∆ G = 2.5 x 8 = 20
New equilibrium Y = 581 + 20 = 601
e. Sir Alan says “let’s not increase G, Let’s reduce T by 8 from 81 to 73. What will happen to the
equilibrium income? Solve for the new equilibrium level of income? Calculate (∆ Y / ∆ T). This
called the tax multiplier.
Answer: GDP = Y = 593
Answer: (∆ Y / ∆ T) = -1.5
e. Suppose Sir Alan’s advisors tell him G should be increased by 20 to from 81 to 101. Sir Alan
says that’s ok as long as the increased spending is financed by raising T by 20. Solve for the
new equilibrium level of income if G increases by 20 from 81 to 101 and the increase in G is
financed by an increase in taxes (T) by 20 from 81 to 101.
Answer: GDP = Y = 601
f. What is the multiplier effect of the increase in G financed by and equal increase in T aimed
at keeping the budget balanced?
Answer: Multiplier = 1.0