Question

a) Given the following simple Keynesian Model: Y = C + I + G + X-M, where Consumption schedule is given as C= 100 +0.75Y Investment (I) = 50 Government (G) = 100 and Net Export (X-M) = 20 i. Calculate the Equlibrium Level of Income [4 Marks] ii. Calculate the size of Consumption at the Equilibrium Level [2 Marks] iii. Calculate the value of the Government Multiplier [2 Marks] iv. Assume Investment (I) changes by 50; calculate the new equilibrium level of Income

Answer 1

(i)

 $Y = C + I + G + X-M$

$Y = 100+0.75Y+50+100+20$

$Y = 270+0.75Y$

$0.25Y = 270$

$Y = 1080$

Equilibrium level of Income is 1080

(ii)

$C = 100+0.75Y$

$C = 100+0.75 \times 1080$

$C = 100+810$

$C = 910$

Size of consumption at equilibrium level is 910

3.

Government Multiplier $= \frac{1}{(1-MPC) }= \frac{1}{(1-0.75)} = \1/0.25 = 4$

Value of Government multiplier is 4

4.

I = 100

Therefore, 

$Y = 100+0.75Y+100+100+20$

$Y = 320+0.75Y$

$0.25Y = 320$

$Y = 1280$

Therefore, new level of equilibrium income is 1280