Question

Suppose an economy is described by following aggregate expenditure (AE) model: C = 10 + 0.8YD I = 30

where C is consumption (0.8 is the marginal propensity to consume) YD is disposable income, and I is investment spending.

1. (a) Derive an expression for AE as a function of Y. Calculate the equilibrium level of Y and illustrate in a diagram with AE on the vertical and Y on the horizontal axis. 

Answer 1

Solution:

AE = AD

Y = AE

Y = C + G + I

 

At equilibrium: Y = AE

Y = C + I

Y = 10 + 0.8 (Y – T) + 30

Y = 10 + 0.8 (Y – 0.3Y) + 30

Y = 10 + 0.8Y – 0.24Y + 30

Y = 10 + 0.56Y + 30

Y – 0.56Y = 40

0.44Y = 40

Y = 91