Question

An economy is described by the following equations: c = 1,500 + 0.75 (y - t), ip = 800, g = 1,500, nx = 100, t = 1,500, y* = 9,150. The multiplier for this economy is 4. Find the effect on short-run equiLiBrium output of _____.

a. An increase in government purchases by 100 from 1,500 to 1,600.
b. A decrease in tax collections from 1,500 to 1,400 (leaving government purchases at their original value of 1,500).
c. A decrease in planned investment spending by 100 from 800 to 700 (leaving government purchases and taxes unchanged at their original values of 1,500).

Answer 1

To calculate the required change in government spending to achieve a potential GDP of 3,500, two methods can be used: directly adjusting the government spending in the AE equation or calculating the multiplier effect and then adjusting G accordingly.

Step-by-step explanation:

To find the equilibrium for this economy with a potential GDP of 3,500 and determine the change in government spending needed to achieve this level, we can use two methods.

First method:

• Calculate the aggregate expenditure (AE) using the given equations AE = C + I + G + (X - M).
• Substitute Y with 3,500 and solve for G.

Second method:

• Calculate the multiplier using the formula 1/(1 - MPC(1 - Tax rate)) and the given values.
• Use the multiplier to determine the change in G needed to reach the potential GDP.

The key is to understand that due to the multiplier effect, the change in government spending has a magnified impact on the overall output.