Suppose that for a particular economy, investment is equal to 200, government purchases are 150, net taxes (that is lump-sum taxes minus transfers) is 100 and consumption is given by C = 100 + 0.75Y (a) What is the level of equilibrium income? (b) Calculate the value of the government expenditure multiplier and the tax multiplier. (c) If government expenditure increases by 200, find the change in equilibrium income.

Question

Philoid · Accepted Answer

Given is –

I = 200

G = 150

T = 100

C = 100 + 0.75 Y

So, C (Autonomous consumption) = 100

And, MPC (c) = 0.75

(a) What is the level of equilibrium income?

Level of equilibrium income = 1/(1-c) [C - cT + I + G]

= 1/ (1 – 0.75) [100+ (0.75 x 100) + 200 + 150]

= 1/0.25 [375]

= 1500

(b) Calculate the value of the government expenditure multiplier and the tax multiplier.

Government expenditure multiplier ∆Y/ ∆G = 1/1-c

= 1/ 1- 0.75

= 1/0.25

= 4

Tax multiplier ∆Y/ ∆T = -c/1-c

= -0.75/0.25

= - 3

(c) If government expenditure increases by 200, find the change in equilibrium income.

New level of equilibrium income = 1/(1-c) [C - cT + I + G + ∆G], Where ∆G = 200

= 2300

Change in equilibrium income = 2300 – 1500 = 800