Question

An economy is described by the following equations:

c = 60 + 0.75(y − t)
ip = 100
g = 150
nx = 30
t = 180
y* = 760
The multiplier in this economy is 4.

Answer 1

Equilibrium in an economy can be found using two methods: direct calculation by plugging in values, and through the multiplier effect. This helps determine the necessary government spending to achieve a desired GDP level.

Step-by-step explanation:

To find the equilibrium in an economy and the change in government spending needed to achieve a potential GDP of 3,500, two approaches can be used: direct calculation by plugging values into the equations and through determination of the fiscal multiplier.

Direct Calculation Approach

Aggregate Expenditure (AE) is defined as AE = C + I + G + X - M, where:

C = Consumption = 400 + 0.85(Y - T)

I = Investment = 300

G = Government Spending

X = Exports = 500

M = Imports = 0.1(Y - T)

T = Taxes = 0.25Y

By setting potential GDP (Y) to 3,500 and solving for G, we adjust government spending to meet the target.

Multiplier Approach

The multiplier is calculated using the formula Multiplier = 1 / (1 - MPC (1 - tax rate)), where MPC is the marginal propensity to consume. The required change in government spending is then determined by multiplying the calculated multiplier with the desired increase in GDP.