Question

Consider the imaginary small country of Torngat. Assume that Torngat is closed to trade, so that its net exports are equal to zero, Suppose that the economy is described by the following consumption function, where C is consumption, Y is income (real GDP), Iₚ is planned investment, G is government purchases; and T is taxes;

C=$25 billion +0.75×(Y−T)
Suppose G=$130 billion, Iₚ =$60 billion, and T=$20 billion.
Given the consumption function and the fact that, in a closed economy, planned expenditure can be calculated as Y=C +Iₚ +G , the equilibrium
​
income level is ______billion.
Suppose that govemment purchases are reduced by $100 billion. The new equilibrium level of income will be equal to ______billion.
Based on the effect of the change in government purchases on equilbrium income, you can tell that this economy's multiplier is equal to______.

Answer 1

In a closed economy, the equilibrium income level is $825 billion. If government purchases are reduced by $100 billion, the new equilibrium income level will be $775 billion. The multiplier for this economy is 4.

Step-by-step explanation:

In a closed economy with no trade, net exports are equal to zero. The consumption function is given by C = $25 billion + 0.75(Y - T), where Y is income, Iₚ is planned investment, G is government purchases, and T is taxes. Given that G = $130 billion, Iₚ = $60 billion, and T = $20 billion, we can calculate the equilibrium income level by setting planned expenditure (Y = C + Iₚ + G) equal to income. By substituting the given values and solving the equation, the equilibrium income level is $825 billion.

If government purchases are reduced by $100 billion, we can calculate the new equilibrium level of income by substituting the new value of G into the equation Y = C + Iₚ + G. The new equilibrium income level will be $775 billion.

The multiplier for this economy can be calculated by using the formula for the spending multiplier: 1 / (1 - MPC), where MPC is the marginal propensity to consume. In this case, MPC is 0.75, so the multiplier is equal to 4. This means that a $1 decrease in government purchases will decrease the equilibrium income level by $4.