Question

C) Consider that you have graduated with PhD in economics, and you have established yourself as a keynesian economist, providing consultancy services to governments around the world. A nation engrossed in a deep recession has learned about you and has requested your assistance in helping to confront the problems associated with their current situation. They provide you with the following information about their economy. Status: An open economy Consumption function: C = 2300 +0.65 Yd, where yd = Y-T Aggregate spending =C+I+G+ X-M, where M= 140 +0.25Yd. Determine the nation's equilibrium real GDP. V=C+I+G = 2300 + ,6564-7) 14G + X - 1401 125 Yd 15 pts.) ii) From your equation showing the equilibrium real GDP, derive . The Government Expenditure multiplier

Answer 1

i) Nation's equilibrium real GDP for an open economy is Y = C+I_g+G+X-M

or, Y = 2300+0.65(Y-T)+I_g+G+X-140-0.25(Y-T)

or, Y-0.65Y+0.25Y = (2300-140)+(-0.65T+0.25T)+I_g+G+X

or, Y(1-0.4) = 2160-0.4T+I_g+G+X

or, Y = (2160-0.4T+I_g+G+X)/(1-0.4) .....(i)

ii) Comparing (i) with Y = A/(1-MPC) where 1/(1-MPC) is the government spending multiplier,

we get, Government spending multiplier = 1/(1-0.4) = 1/0.6 = 1.67