Question

The following information refers to the spending in Laddacity Country.(All values are in
USD million).
Consumption Function 350+0.65Y d
Investment Expenditure 150
Public Expenditure 250
Tax 20
Net Exports 120

A. Compute the equilibrium level of national income for the above economy?
B. Assuming that full employment would be experienced at an income level of USD3000
million, State the problem this economy is facing, illustrate your answer with a well-
labeled diagram.
C. Using the spending multiplier compute the change in the amount of government
spending that is required to achieve the full employment income level
D. What is the marginal propensity to save (MPS) and the relationship between MPS and
marginal propensity to consume (MPC)?

Answer 1

A) $AD=Y=C+I+G+Xn$

$Yd=Y-Tax$

$Y=350+0.65(Y-20)+150+250+120$

$Y=870+0.65Y-13$

$0.35Y=857$

$Y=2448.57 million$

B) If $Y=3000$

$C=350+0.65(3000-20)=2287$

$AD=2287+150+250+120=2807$

Y>AD As a result savings increase, manufacturers reduce production. The crisis of overproduction in the economy.

C) $MPC=\Delta C/\Delta Y=(2287-1928.57)/(3000-2448.57)=0.65$

$MG=1/(1-MPC)=2.86$

$G=(Y-AD)/MG=193/2.86=67.48$

D) $MPS=1-MPC=1-0.65=0.35$