Answer to Question #227910 in Macroeconomics for hafsa

Question

Suppose the consumption behavior in problem 1 changes so that C=100+0.9Y. while I remains at 50. a. Is the equilibrium level of income higher or lower than it was in problem 1(a)? calculate the new equilibrium level, Y’, to verify this. b. Now suppose investment increases to I=100, just as in problem 1(d) . what is the new equilibrium income? c. Does this change in investment spending have more or less of an effect on Y than it did in problem 1? Why? d. Draw a diagram indicating the change in equilibrium income in this case.

Answer 1

(a) We expect a higher equilibrium income level than the previous. We can assume it moved from 0.8 to 0.9.

New equilibrium;

AD =C $+$ I =100$+$ 0.9Y$+$ 50

150 $+$ 0.9Y

Y= AD

Y $=$ 150 $+$ 0.9Y

Y $-$ 0.9Y $=$ 150

$\frac{0.1Y}{0.1}$$=\frac{150}{0.1}$

Y=1500

Since MPC is 0.9the multiplier (a) will be equal to 1 (1-0.9)= 10

(b) From $\Delta$ Y $=$ (multiplier) ($\Delta$I)$=$ 100 $\times$ 50 $=$500

Y1 = Y0 $+$ $\Delta$ Y

$=$1500 $+$ 500

=2000

(c) The change in I now has a bigger impact (double).

(d) Multiplier has doubled from a=5 to a= 10. The change in output(Y) that results from change in investment (I) now has also doubled fro. 250 to 500.