Question

For the data in the following table, the consumption function is C = 150 + 0.6(Y-T). Fill in the columns in the table: PLANNED PLANNED UNPLANNED NET DISPOSABLE CONSUMPTION INVESTMENT GOVERNMENT AGGREGATE INVENTORY OUTPUT TAXES INCOME SPENDING SAVING SPENDING PURCHASES EXPENDITURES CHANGE 1,050 50 150 200 1,550 50 200 2,050 50 150 200 150 Use your answers in the previous problem to answer the following questions: 1) How much of an increase in spending would be required to generate an increase of 300 in the equilibrium level of output? 2) How much of a decrease in taxes would be required to generate an increase of 300 in the equilibrium level of output? 3) If you want to increase the output level by 300 without increasing the deficit, how much of a simultaneous increase in government spending (G) and taxes (T) would do it?

Answer 1

DI = Y - T

C = 150 + 0.6(Y - T)

S = Y - C

PAE = C + I + G

Unplanned inventory change = Y - PAE

Y	T	Yd	C	S	I	G	AE	Unplanned Inventory
1,050	50	1,000	750	300	150	200	1,100	-50
1,550	50	1,500	1,050	500	150	200	1,400	150
2,050	50	2,000	1,350	700	150	200	1,700	350

(1)

Spending Multiplier = 1 / (1 - MPC) = 1 / (1 - 0.6) = 1/0.4 = 2.5

Increase in spending = Increase in Y / Spending Multiplier = 300 / 2.5 = 120

(2)

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

Decrease in tax = Increase in Y / Tax Multiplier = 300 / 1.5 = 200

(2)

Balanced budget multiplier being equal to 1,

Increase in spending = Decrease in tax = Targeted Increase in Y = 300