Question

Make use of following information to answer the following questions: (CLO\#4) (MUST SHOW CALCULATION) (15) C=100+0.75Y D;I=100AED;G=50AED,TAX(T)= 20 AED

a. Calculate equilibrium income Y in AED.
(5) b. Calculate equilibrium DISPOSABLE income Y
D ∗ in AED.
(1) c. Calculate equilibrium Consumption C in AED.
(3) d. Calculate equilibrium Savings S
∗
in AED. Assume that in equilibrium income, S=I(1) e. Calculate government expenditure multiplier from above information. If government increases its expenditure by 20AED, how much equilibrium income will increase? Explain. (2.5) f. Calculate Tax multiplier from above information. If Tax, T increases by 20AED, how much equilibrium income will fall?

Answer 1

To find the equilibrium in this economy, set Aggregate Expenditure equal to national income. Substitute the consumption, investment, government spending, taxes, exports, and imports according to provided formulas and solve for Y. Two methods to achieve potential GDP include solving directly for government spending and using the government expenditure multiplier.

Step-by-step explanation:

To find the equilibrium income Y in this economy, we set Aggregate Expenditure (AE) equal to national income (Y). The Aggregate Expenditure (AE) is the sum of Consumption (C), Investment (I), Government spending (G), Exports (X), and minus Imports (M) which depend on net taxes (T).

The equation for AE thus becomes:

AE = C + I + G + X - M

Inserting the given values and formulas:

AE = (400 + 0.85(Y - T)) + 300 + 200 + 500 - 0.1(Y - T)

Substitute T = 0.25Y to get:

AE = 400 + 0.85(Y - 0.25Y) + 300 + 200 + 500 - 0.1(Y - 0.25Y)

Simplify and solve for Y:

AE = Y = 1400 + 0.7625Y - 0.1(0.75Y)

AE = Y = 1400 + 0.6375Y

This simplifies to:

Y = 1400 / (1 - 0.6375) = 1400 / 0.3625

Y = 3863 AED (approximately)

To achieve a potential GDP of 3,500, we can adjust government spending. One way is to plug 3,500 into the equations and solve for G:

3500 = 400 + 0.85(3500 - 0.25*3500) + I + G + X - 0.1(3500 - 0.25*3500)

After plugging in the values for I and X and simplifying, solve for G.

Another way is to calculate the government expenditure multiplier and determine the necessary change in G to reach the potential GDP of 3,500.