Question

hestion Completion Status: QUESTION Consider a private, closed economy where aggregate consumption C depends on aggregate income Y according to the equation C. 15 0.5 Y. where planned investment is IP - 15. Using the above information, complete the following table: Y c R AER_ where AEP stands for aggregate expenditure planned. 1) Suppose that the GDP initially is Y 50. Obtain the corresponding levels of savings S and unplanned investment Is Y = 40 an income. expenditure equilibrium? If not, what adjustment of inventories would you expect it to take place towards an equilibrium, and what will be the equilibrium GDP? i) Obtain the marginal propensity to save MPS and the spending multiplier. IV) Suppose that favorable expectations about future economic activity cause autonomous consumption to increase to 25 and planned investment to increase to 15. What is the new equilibrium GDP? () is the change in the equilibrium GDP larger or smaller than the change of autonomous spending that caused it? Carefully explain why, briefly sketching the theory of the business cycle that underlies this example.

Answer 1

# C= 15+0•5Y, I = 15

* 1)

Y $	C ( c+ 0•5y)$	I$	AE(C+I)$
0	15 {15+0•5(0)}	15	30
10	20	15	35
20	25	15	40
30	30	15	45
40	35	15	50
50	40	15	55
60	45	15	60
70	50	15	65
80	55	15	70

2) Suppose, that GDP initially is Y= 50 , the corresponding levels of saving ,S & unplanned investment are------_-

S= 10. ( S=y-c or 50-40)

unplanned investment= 5. (AE-Y or 55-50 ,it is unplanned inventory investment)

# If Y= 40, there is no income and expenditure Equilibrium .

( Equilibrium occurs where AS(orY)= AE(or AD) & at y=40,AE= 50, so no Equilibrium level)

*The inventory adjustment expected to be taken place towards an equilibrium is------10

* The Equilibrium GDP will be ------ 40

#3) Marginal Propensity to save( MPC) -----0•5

(MPS= 1-MPC

MPC= 0•5, so MPS= 0•5)

*Multiplier (K)= 2

( K= 1/MPS or 1/1-MPC

1/0•5= 2 times

#4) If autonomous Consumption is 25,planned investment =15,

* New Equilibrium GDP=80

Explanation---------

C= 25+0•5Y

At Equilibrium , AS(orY)=AE(orAD)

See the table----

Y(AS)	C (25+0•5y)	Ip	AE (C+I)
0	25	15	40
10	30	15	45
20	35	15	50
30	40	15	55
40	45	15	60
50	50	15	65
60	55	15	70
70 80	60 65	15 15	75 80

5) Change in GDP is larger than the increase in autonomous spending that caused it.

Equilibrium GDP =80 ,where Y = AE=80

* Theory of business cycle-----

Samuelson's Model of multiplier Acceleration Interaction is best related to above case.

-- His theory states that multiplier and Accelerator are both two factors which are related to business cycle.

- Autonomous and derived Consumption is responsible for creating Economic fluctuations.

- A little bit of increase in autonomous Consumption brings about a big increase in GDP,which is called multiplier effect.

That is why, when autonimous Consumption changes , the Equilibrium GDP changes larger than it,as initially , autonomous Consumption was 15 and Equilibrium GDP was 60, now Autonomous Consumption is 25, equlibrium GDP = 80.

Thanks.....