Consider two hypothetical economies that are perfectly similar except for their marginal propensity to consume (MPC). Each economy is currently in equilibrium with real income and planned expenditure equal to $100 billion, as given by the black points (plus signs) on the following two graphs. Assume that both economies are closed to trade, and that neither economy has taxes that change with income. The graphs also plot the 45-degree line. The first economy has an MPC equal to 0.5. Therefore, its initial planned expenditure line has a slope of 0.5 and passes through the point (100, 100). The second economy has an MPC equal to 0.75. Therefore, its initial planned expenditure line has a slope of 0.75 and passes through the point (100, 100). Now, suppose there is an increase of $20 billion in planned investment in each economy. In the first economy (with MPC = 0.5), the $20 billion increase in planned investment causes equilibrium income to increase by billion. In the second economy (with MPC = 0.75), the $20 billion increase in planned investment causes equilibrium income to increase by billion. Therefore, a higher MPC is associated with a multiplier. Now, confirm your graphical analysis algebraically using the formula for the multiplier: Multiplier = 11−MPC For the first economy with an MPC of 0.5, the effect of the $20 billion increase in planned investment becomes the following: Change in Equilibrium Real Income = Change in Planned Expenditure × Multiplier = × = × = Using the same method, the multiplier for the second economy is
Consider two hypothetical economies that are perfectly similar except for their marginal propensity to consume (MPC). Each economy is currently in equilibrium with real income and planned expenditure equal to $100 billion, as given by the black points (plus signs) on the following two graphs. Assume that both economies are closed to trade, and that neither economy has taxes that change with income. The graphs also plot the 45-degree line. The first economy has an MPC equal to 0.5. Therefore, its initial planned expenditure line has a slope of 0.5 and passes through the point (100, 100). The second economy has an MPC equal to 0.75. Therefore, its initial planned expenditure line has a slope of 0.75 and passes through the point (100, 100). Now, suppose there is an increase of $20 billion in planned investment in each economy. In the first economy (with MPC = 0.5), the $20 billion increase in planned investment causes equilibrium income to increase by billion. In the second economy (with MPC = 0.75), the $20 billion increase in planned investment causes equilibrium income to increase by billion. Therefore, a higher MPC is associated with a multiplier. Now, confirm your graphical analysis algebraically using the formula for the multiplier: Multiplier = 11−MPC For the first economy with an MPC of 0.5, the effect of the $20 billion increase in planned investment becomes the following: Change in Equilibrium Real Income = Change in Planned Expenditure × Multiplier = × = × = Using the same method, the multiplier for the second economy is
Chapter9: Demand-side Equilibrium: Unemployment Or Inflation?
Section9.A: The Simple Algebra Of Income Determination And The Multiplier
Problem 4TY
Related questions
Question
Consider two hypothetical economies that are perfectly similar except for their marginal propensity to consume (MPC). Each economy is currently in equilibrium with real income and planned expenditure equal to $100 billion, as given by the black points (plus signs) on the following two graphs. Assume that both economies are closed to trade, and that neither economy has taxes that change with income. The graphs also plot the 45-degree line.
The first economy has an MPC equal to 0.5. Therefore, its initial planned expenditure line has a slope of 0.5 and passes through the point (100, 100).
The second economy has an MPC equal to 0.75. Therefore, its initial planned expenditure line has a slope of 0.75 and passes through the point (100, 100).
Now, suppose there is an increase of $20 billion in planned investment in each economy.
In the first economy (with MPC = 0.5), the $20 billion increase in planned investment causes equilibrium income to increase by
billion. In the second economy (with MPC = 0.75), the $20 billion increase in planned investment causes equilibrium income to increase by
billion. Therefore, a higher MPC is associated with a multiplier.
Now, confirm your graphical analysis algebraically using the formula for the multiplier:
| Multiplier | = | 11−MPC |
For the first economy with an MPC of 0.5, the effect of the $20 billion increase in planned investment becomes the following:
| Change in Equilibrium Real Income | = | Change in Planned Expenditure | × | Multiplier |
| = | × | |||
| = | × |
|
||
| = |
Using the same method, the multiplier for the second economy is .
Transcribed Image Text:Place a green line (triangle symbol) on each of the preceding graphs to indicate the new planned expenditure line for each economy. Then place a
black point (plus symbol) on each graph showing the new level of equilibrium income. (Hint: You can see the slope and vertical axis intercept of a line
on the graph by selecting it.)
PLANNED EXPENDITURE (Billions of dollars)
200
180
160
140
120
100
80
60
40
20
0
AE Line
0 20
MPC=0.5
40
45-Degree Line
60 80 100 120 140
REAL INCOME (Billions of dollars)
160 180
200
New AE Line
New Equilibrium
(?)
Expert Solution
This question has been solved!
Explore an expertly crafted, step-by-step solution for a thorough understanding of key concepts.
This is a popular solution!
Trending now
This is a popular solution!
Step by step
Solved in 3 steps with 3 images
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, economics and related others by exploring similar questions and additional content below.Recommended textbooks for you
