Question

Given the following model:

Consumption: C = 500 + 0.5Yd

 Investment: I = 250

Government Expenditure: G = 100

Proportional Tax Rate: t = 0.1

Imports: M = 0.25Y

Exports: X = 50

(Note: There is no lump-sum tax)

1. a) If the current level of output is 1000, what is the level of actual investment? (2 marks)
2. b) Calculate the equilibrium real GDP (2 marks)

Answer 1

Since this is an open economy, the national income $Y$ is given as below;

$$Y=C+I+G+X-M$$

a) Given $Y$ as 1000, then actual investment can be obtained as

$$Y=1000,\ C=500+0.5Yd,\ G=100, X-M=200,M=0.25X1000=250$$

Actual investment

$$I=Y-C-G-(X-M)\\ I=1000-500+0.5Yd-100-250$$

b) Equilibrium

$$Y=300+0.5(Y-0.1) +250+100+250\\ =500+0.5Y-0.05+350+200\\ 0.95Y=1050\\ Y_e=1105.26$$