ENGR.ECONOMIC ANALYSIS
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ISBN: 9780190931919
Author: NEWNAN
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Consider a closed economy with fixed prices and wages. Suppose consumption function takes the form C = 150+0,8Yd, Investments are I = 200, government purchases are G = 350, tax rate t= 0,1. There are no lump-sum taxes. (some calculations are added in the images)
1)Compute the government spending multiplier before and after changes in tax rate. Explain why multiplier is changed?
2) If the potential output is 3000 and economy is in initial equilibrium (a) what changes in government purchases the Government need to implement in order to achieve potential output? Show how changes in government purchases affect the planned aggregate spending line and new equilibrium output.
Transcribed Image Text:Step 1
The equilibrium output and budget deficit are as follows:
Y=C+I+ G
Y=150 + 0. 8 (Y – 0. 1Y) + 200 + 350
Y=700 + 0. 72Y
Y=700
0.28
Y=2, 500
Budget Deficit=Tax Revenue – Government Expenditure
=(2, 500 x 0. 1) – 350
=-100
Hence, the equilibrium level of output is 2,500 and the budget deficit is 100, this can be seen in the diagram
below:
Aggregate
Expenditure
45°
Aggregate
Expenditure
(C+l+G)
2,500
GDP
Transcribed Image Text:Step 2
If there is a balanced budget then the new tax rate would be:
tY=350
2, 5001=350
350
2,500
t=0. 14
Hence, the new tax rate would be 0.14 or 14%.
Step 3
The new equilibrium output after the change in the tax rate would be as follows:
Y=C+I+G
Y=150 +0.8 (Y – 0. 14Y) + 200 + 350
Y=700 + 0. 688Y
700
0.312
Y=2, 243. 6
Hence, the new equilibrium output will be 2,243.6. This can also be shown graphically as:
Aggregate
Expenditure
Aggregate
Expenditure
(C+l+G)
45°
Aggregate
Expenditure 1
(C1+l+G)
2,243.6 2,500
GDP
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