Question

Oh My God is a closed economy where the consumption function is represented by C = 100 + (0.75) (Y- T), investment is equal to 300 units and government purchases are equal to 300 Government revenue is represented by T = 100+ (0,5)Y. Assume that the economy today has a level GDP equal to 1000 (not necessarily the equilibrium level of GDP). With these data we know that in the short run the level of GDP should:

Answer 1

To determine the equilibrium GDP level and calculate the change in government spending required to reach a potential GDP of 3,500, one must use the aggregate expenditures model by setting AE equal to GDP and solving for Y. This includes using the consumption function, investment level, imports, exports, and adjusting government spending. The multiplier effect plays a crucial role in these calculations.

Step-by-step explanation:

To find the equilibrium level of GDP in this economy, we need to set aggregate expenditures (AE) equal to GDP (Y). Aggregate expenditures consist of consumption (C), investment (I), government spending (G), exports (X), and imports (M). The consumption function is given by C = 400+ 0.85(Y - T), and the tax function is T = 0.25Y. With investment (I) fixed at 300, government spending (G) at 200, and exports (X) at 500, while imports (M) are 0.1(Y-T), we have AE = 400+ 0.85(Y - 0.25Y) + 300 + 200 + 500 - 0.1(Y - 0.25Y).To find the equilibrium, we solve the equation AE = Y:Replace Y with AE and T with 0.25Y in the AE equation.Rearrange and combine like terms to solve for Y.Then, to find the change in G needed to achieve a potential GDP of 3,500, we plug 3,500 into the original AE equation and solve for the new value of G. Alternatively, calculate the multiplier and use it to determine the change in G needed for the economy to reach 3,500.The multiplier effect is essential for understanding how changes in government spending can influence GDP levels and help the economy reach its potential GDP.