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.

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