Question

5. Let C=120+0.6Yd, I=140, G=200, T=100. (a) What are government spending multiplier, tax multiplier, and balanced-budget multiplier? 0) What are be supue com (b) What are the output, consumption, saving, and budget deficit at the equilibrium? pusa aning and budget details equivat (c) What are the output, consumption, and saving if the government changes the budget deficit to zero by a change in G. G decreases 100 (d) What are the output, consumption, and saving if the government changes the budget deficit to zero by a change in T. Tincreases 100 EFFE

Answer 1

(a)

C = 120 + 0.6Yd

So,

MPC = 0.6

Calculate the government spending multiplier -

Government spending multiplier = 1/(1-MPC) = 1/(1-0.6) = 1/0.4 = 2.5

Thus,

The government spending multiplier is 2.5

Calculate the tax multiplier -

Tax multiplier = -MPC/(1-MPC) = -0.6/(1-0.6) = -0.6/0.4 = -1.5

Thus,

The tax multiplier is -1.5

Calculate the balanced budget multiplier -

Balanced budget multiplier = Government spending multiplier + Tax multiplier = 2.5 + (-1.5) = 2.5 - 1.5 = 1

Thus,

The balanced budget multiplier is 1

(b)

At equilibrium,

Y = C + I + G

Y = 120 + 0.6Yd + 140 + 200

Y = 460 + 0.6(Y - T)

Y = 460 + 0.6(Y - 100)

Y = 460 + 0.6Y - 60

Y = 400 + 0.6Y

Y - 0.6Y = 400

0.4Y = 400

Y = 400/0.4

Y = 1,000

C = 120 + 0.6Yd

C = 120 + 0.6(Y - T)

C = 120 + 0.6(1000 - 100)

C = 120 + [0.6 * 900]

C = 120 + 540

C = 660

Budget deficit = G - T = 200 - 100 = 100

At equilibrium, saving equals investment.

Investment is 140. So, saving would be 140

Thus,

At equilibrium,

Output = 1,000

Consumption = 660

Saving = 140

Budget deficit = 100

(c)

Now, G decreases by 100.

At equilibrium,

Y = C + I + G

Y = 120 + 0.6Yd + 140 + 100

Y = 360 + 0.6(Y - T)

Y = 360 + 0.6(Y - 100)

Y = 360 + 0.6Y - 60

Y = 300 + 0.6Y

Y - 0.6Y = 300

0.4Y = 300

Y = 300/0.4

Y = 750

C = 120 + 0.6Yd

C = 120 + 0.6(Y - T)

C = 120 + 0.6(750 - 100)

C = 120 + [0.6 * 650]

C = 120 + 390

C = 510

At equilibrium, saving equals investment.

Investment is 140. So, saving would be 140

Thus,

At equilibrium,

Output = 750

Consumption = 510

Saving = 140

(d)

Now, T increases by 100

At equilibrium,

Y = C + I + G

Y = 120 + 0.6Yd + 140 + 200

Y = 460 + 0.6(Y - T)

Y = 460 + 0.6(Y - 200)

Y = 460 + 0.6Y - 120

Y = 340 + 0.6Y

Y - 0.6Y = 340

0.4Y = 340

Y = 340/0.4

Y = 850

C = 120 + 0.6Yd

C = 120 + 0.6(Y - T)

C = 120 + 0.6(850 - 200)

C = 120 + [0.6 * 650]

C = 120 + 390

C = 510

At equilibrium, saving equals investment.

Investment is 140. So, saving would be 140

Thus,

At equilibrium,

Output = 850

Consumption = 510

Saving = 140