Equilibrium and Multiplier Effect in an Economy
What are the equations describing an economy?
The economy is described by the following equations:
- c = 60 + 0.75(y − t)
- ip = 100
- g = 150
- nx = 30
- t = 180
- y* = 760
What is the multiplier in this economy?
The multiplier in this economy is 4.
Equilibrium Calculation Methods
Equilibrium in an economy can be found using two methods: direct calculation by plugging in values, and through the multiplier effect. This helps determine the necessary government spending to achieve a desired GDP level.
To find the equilibrium in an economy and the change in government spending needed to achieve a potential GDP of 3,500, two approaches can be used: direct calculation by plugging values into the equations and through determination of the fiscal multiplier.
Direct Calculation Approach
Aggregate Expenditure (AE) is defined as AE = C + I + G + X - M:
- C = Consumption = 400 + 0.85(Y - T)
- I = Investment = 300
- G = Government Spending = 150
- X = Exports = 500
- M = Imports = 0.1(Y - T)
- T = Taxes = 0.25Y
By setting potential GDP (Y) to 3,500 and solving for G, we adjust government spending to meet the target.
Multiplier Approach
The multiplier is calculated using the formula Multiplier = 1 / (1 - MPC (1 - tax rate)), where MPC is the marginal propensity to consume. The required change in government spending is then determined by multiplying the calculated multiplier with the desired increase in GDP.