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Exercises · Q6

Q.Consider an economy described by the following functions: C=20+0.80 YC = 20 + 0.80\,Y, I=30I = 30, G=50G = 50, TR=100TR = 100.

(a) Find the equilibrium level of income and the autonomous expenditure multiplier in the model.
(b) If government expenditure increases by 30, what is the impact on equilibrium income?
(c) If a lump-sum tax of 30 is added to pay for the increase in government purchases, how will equilibrium income change?
Telangana TsbieTextbookSubjective· 5mImportance★★★★★
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With C=20+0.80 YC = 20 + 0.80\,Y, I=30I = 30, G=50G = 50, TR=100TR = 100: equilibrium income is Y=900Y = 900 and the autonomous-expenditure multiplier is 55. A ΔG=30\Delta G = 30 raises income by 150150 (to 10501050); financing it with a lump-sum tax of 3030 leaves a net rise of 3030 (to 930930) — the balanced-budget multiplier.

Concept: aggregate-demand equilibrium

Equilibrium income is where output equals planned aggregate demand, Y=C+I+GY = C + I + G. Consumption depends on disposable income Yd=Y−T+TRY_d = Y - T + TR, while II and GG are autonomous. The multiplier k=11−ck = \tfrac{1}{1-c} magnifies any change in autonomous spending, because each injection becomes income that is partly re-spent.

(a) Equilibrium income and the multiplier

With no tax, Yd=Y+TR=Y+100Y_d = Y + TR = Y + 100, so

C=20+0.80(Y+100)=100+0.80 Y.C = 20 + 0.80(Y + 100) = 100 + 0.80\,Y.

Y=C+I+G=(100+0.80 Y)+30+50=180+0.80 Y.Y = C + I + G = (100 + 0.80\,Y) + 30 + 50 = 180 + 0.80\,Y.

0.20 Y=180⇒Y=1800.20=900.0.20\,Y = 180 \quad\Rightarrow\quad Y = \frac{180}{0.20} = 900.

The autonomous-expenditure multiplier is …

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