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Introduction To Economics: Exercise 8

This document provides an introduction to economics through two exercises that model consumption, investment, taxes, and equilibrium output in a closed economy. The first exercise defines consumption and investment functions to find the equilibrium level of income and shows how it would change with a decrease in investment. The second exercise adds government spending and taxes to the model to calculate the multiplier effect of changes in government expenditure. Both exercises demonstrate basic economic concepts like the marginal propensity to consume, save, and invest. The document concludes by asking if this model could help explain the global economic crisis and related policy responses.

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44 views1 page

Introduction To Economics: Exercise 8

This document provides an introduction to economics through two exercises that model consumption, investment, taxes, and equilibrium output in a closed economy. The first exercise defines consumption and investment functions to find the equilibrium level of income and shows how it would change with a decrease in investment. The second exercise adds government spending and taxes to the model to calculate the multiplier effect of changes in government expenditure. Both exercises demonstrate basic economic concepts like the marginal propensity to consume, save, and invest. The document concludes by asking if this model could help explain the global economic crisis and related policy responses.

Uploaded by

Vraj
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Introduction to Economics

Exercise 8

1. Assume we have a closed economy (i.e. no trade sector) and no government sector. The
consumption function for the economy is given by:

C = 10 + 0.80Y

and investment demand (I) is fixed at 100.

(a) Write down an expression for the saving function and roughly draw the saving and
consumption functions.

(b) What is the value of the marginal propensity to consume (MPC) and the marginal
propensity to save (MPS) in this case? Explain what these mean.

(c) Find the value for the equilibrium level of income.

(d) If investment demand falls by 1 unit, what happens to equilibrium output?

(e) How could you use this model to show the output effects of a decrease in business and
consumer confidence?

2. Assume the consumption function for an economy is given by:

C = 42 + 0.8Y d

where C = consumption and Yd = disposable income. The tax function is given by:

T = 0.1Y

and investment is fixed at 150. while government expenditure is fixed at 200.

(a) Find the equilibrium level of output for this economy.

(b) What is the government expenditure multiplier in this case?

(c) If full employment or potential output is 1600, how much would government
expenditure have to increase by to achieve this level of output?

3. Do you think this model is of any use to explain to some extent the world economic crisis
and the policy response? Explain.
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