Economic Assignment

Economic Assignment



Economic Assignment

1. In a closed economy without a government sector, consumption is determined as 80% of the income available to households. Investment is autonomous at a level of £450.

(a) What is the equilibrium level of income?

Solution

C= 0.8Y

Y         =          0.8Y + 450

                                    Y - 0.8Y         =          450

                                   0.2Y   =          450

                                               Y         =          2250

The equilibrium level of income is Y           =          2250

(b) What would equilibrium income be if investment increased by £50?

The equilibrium condition is given as Y = C + I

Thus, Y         =          0.8Y + 500

                                    Y - 0.8Y         =         500

                                   0.2Y                =          500

                                               Y         =          500 / 0.2

Hence, the equilibrium level of income is 2500

When investment is increased by £ 50, from £450 to £ 500, the equilibrium level increases from 2250 to 2500.

(c) Calculate the value of the multiplier, given the change in investment.

b=0.8

The multiplier effect is

                        M         =            1        1 - b

                                                =          1      1 - 0.8

                                                =          1      0.2

The multiplier effect is m is 5

(d) Explain, as if you were explaining to your (non-economist) grandparents, the meaning of the multiplier you found in (c).

Multiplier is a term used to measure the effect exerted by the alteration of one of the variables of aggregate demand on national income. For example, an increase in investment by a value of 50 £, the multiplier is five. Its name derives from the fact that the magnitude of the change in income is greater than the magnitude of change in the variable that causes the change in income, there is an effect amplified. This means when investment is increased by £ 50, the level of equilibrium increases 5 times of the increased investment, that is £ 250.

Now suppose that that the government levies direct taxes of 10% of income and undertakes expenditure of £250, with investment back at £450:

(e) What is the equilibrium level of income?

Solution

The equilibrium condition is given as Y = C + I + G

Here, C         =          250 + 0.8Yd

                        C         =          250 + 0.8(Y - T)

                        C         =          250 + 0.8(Y - 0.10Y)

                        C         =          250 + 0.8(0.9Y)

                        C         =          250 + 0.72YThus,                        Y         =          250 + 0.72Y + 450 + 250

            Y - 0.72 Y      =          250 + 450 + 250

                        0.28Y  =          950

                        Y         =          950 / 0.28

The equilibrium level of income is £ 949.7

(f) Calculate disposable income, consumption and aggregate demand.

Y = C + I + G

Y = 250 + 450 + 250

Y = 950

DI = Y - T

DI = 950 - 95

DI = £855

Aggregate Demand

AD = C + I + G

AD = 250 + 450 +250

AD = 950

2. The government spends £6 billion to build a rail track. The income tax rate is 0.2 and the MPC out of disposable income is 0.9.

(a) Calculate the effect on equilibrium income and output. Draw a diagram to illustrate and explain how a change in government spending alters income and output.

Output effect = 1 / (1-MPC (1-t))

Output = 1 / (1 - ...