Question

C = $400 billion 0.5yd i = $300 billion g = $400 billion given yf and after solving for ye, what problem is this economy confronted with? how could the government eliminate the problem with: a change in tax? a change in government spending?

Answer 1

To achieve a potential GDP of $3,500, we can calculate the equilibrium national income using the provided equations and adjust government spending accordingly. Two approaches are direct calculation and using the fiscal multiplier to determine the necessary change in government spending.

Step-by-step explanation:

The question is about finding the equilibrium in an economic model and adjusting government spending to reach full employment or potential GDP. To find the equilibrium, we set Aggregate Expenditure (AE) equal to national income (Y). Using the provided equations:
AE = C + I + G + X - M
and inserting the specific values and expressions for taxes (T), consumption (C), and imports (M), the equilibrium condition becomes:

Y = 400 + 0.85(Y - T) + 300 + G + 500 - 0.1(Y - T)

After substituting T with 0.25Y, we can solve for Y, which represents the equilibrium national income.

To achieve the potential GDP of $3,500, we can either solve directly by plugging Y into the equilibrium equation or we can use the fiscal multiplier approach. The fiscal multiplier can be calculated as 1 / (1 - MPC * (1 - t)), where MPC is the marginal propensity to consume and t is the tax rate. The needed change in government spending can then be determined by multiplying the fiscal multiplier by the GDP gap, which is the difference between the potential GDP and the current equilibrium GDP.