Suppose that the initial output equilibrium was 200 units As

Suppose that the initial output equilibrium was 200 units. Assume that the consumption function is: C=25+0.8Y_D

Suppose there is now a decline in inestment of 8 units.

a)What will be the new equilibrium level of income? SHOW ALL STEPS.

b)What increase in government spending would be required to restore an income to the intital level of 200? SHOW ALL STEPS.

c)Alternatively, what reduction in tax collections would be sufficient to restore an income level of 200? SHOW ALL STEPS.

Solution

a.

The multiplier in this economy is 0.8

If it declines by 8 units = 0.8*200 = 160 units fall

b.

40 units have to be added to make it 200 again.