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5. Let C=120+0.6Yd, I=140, G=200, T=100. (a) What are government spending multiplier, tax multiplier, and balanced-budget mul

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Answer #1

(a)

C = 120 + 0.6Yd

So,

MPC = 0.6

Calculate the government spending multiplier -

Government spending multiplier = 1/(1-MPC) = 1/(1-0.6) = 1/0.4 = 2.5

Thus,

The government spending multiplier is 2.5

Calculate the tax multiplier -

Tax multiplier = -MPC/(1-MPC) = -0.6/(1-0.6) = -0.6/0.4 = -1.5

Thus,

The tax multiplier is -1.5

Calculate the balanced budget multiplier -

Balanced budget multiplier = Government spending multiplier + Tax multiplier = 2.5 + (-1.5) = 2.5 - 1.5 = 1

Thus,

The balanced budget multiplier is 1

(b)

At equilibrium,

Y = C + I + G

Y = 120 + 0.6Yd + 140 + 200

Y = 460 + 0.6(Y - T)

Y = 460 + 0.6(Y - 100)

Y = 460 + 0.6Y - 60

Y = 400 + 0.6Y

Y - 0.6Y = 400

0.4Y = 400

Y = 400/0.4

Y = 1,000

C = 120 + 0.6Yd

C = 120 + 0.6(Y - T)

C = 120 + 0.6(1000 - 100)

C = 120 + [0.6 * 900]

C = 120 + 540

C = 660

Budget deficit = G - T = 200 - 100 = 100

At equilibrium, saving equals investment.

Investment is 140. So, saving would be 140

Thus,

At equilibrium,

Output = 1,000

Consumption = 660

Saving = 140

Budget deficit = 100

(c)

Now, G decreases by 100.

At equilibrium,

Y = C + I + G

Y = 120 + 0.6Yd + 140 + 100

Y = 360 + 0.6(Y - T)

Y = 360 + 0.6(Y - 100)

Y = 360 + 0.6Y - 60

Y = 300 + 0.6Y

Y - 0.6Y = 300

0.4Y = 300

Y = 300/0.4

Y = 750

C = 120 + 0.6Yd

C = 120 + 0.6(Y - T)

C = 120 + 0.6(750 - 100)

C = 120 + [0.6 * 650]

C = 120 + 390

C = 510

At equilibrium, saving equals investment.

Investment is 140. So, saving would be 140

Thus,

At equilibrium,

Output = 750

Consumption = 510

Saving = 140

(d)

Now, T increases by 100

At equilibrium,

Y = C + I + G

Y = 120 + 0.6Yd + 140 + 200

Y = 460 + 0.6(Y - T)

Y = 460 + 0.6(Y - 200)

Y = 460 + 0.6Y - 120

Y = 340 + 0.6Y

Y - 0.6Y = 340

0.4Y = 340

Y = 340/0.4

Y = 850

C = 120 + 0.6Yd

C = 120 + 0.6(Y - T)

C = 120 + 0.6(850 - 200)

C = 120 + [0.6 * 650]

C = 120 + 390

C = 510

At equilibrium, saving equals investment.

Investment is 140. So, saving would be 140

Thus,

At equilibrium,

Output = 850

Consumption = 510

Saving = 140

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