You should have three equations firmly in mind--equations that pertain
generally to any macroeocnomy.
|I. Y = C + I + G
II. C = a + bY
III. Y = C + S
|The equality between Y, which represents income, and C +
I + G, which represents total expenditures (or aggregate demand), is the
(Keynesian) equilibrium condition.
This simple linear equation shows the general form of the relationship between income and consumer speding. It describes consumer behavior. a > 0; 0 < b < 1.
In the absence of taxation, this equation is an identity which defines savings. That is, saving (S) is defined as that part of income not spent on consumption goods (Y - C). With taxation, we would write Y = C + S + T.
|i. C = 100 + 0.8Y
ii. I = 50
iii. G = 60; T = 0
iv. Yfe = 1300
|This is a specific consumption equation that describes the
consumption behavior in some particular economy during some particular
period of time.
This magnitude represents the current level of investment, which is based on the prevailing state of business confidence.
These magnitudes represent the current levels of government spending and taxation. (Query: How is the government financing G if T is 0?)
This is the full-employment level of income--the level of income that reflects an absence of (cyclical) unemployment and corresponds to a wage rate that clears the labor market.
1. What is the MPC?, the MPS? What is the significance of the "100" in the equation C = 100 + 0.8Y?
2. Calculate the investment multiplier and the government-spending multiplier.
3. Write the specific saving equation that corresponds to the consumption equation.
4. At what level of income does savings equal zero?
5. How much is aggregate demand when income is 1100? Is the economy in equilibrium at this level of income?
6. Sketch the aggregate demand curve and the 45o line and locate Y=1100 and Y=1300 (relative to equilibrium income).
7. What is the equilibrium level of income? (Describe the economic process that brings about this Keynesian equilibrium.)
8. Suppose that the government raises the level of government spending by 30. What does this do to the equilibrium level of income?
9. How much more government spending is required to achieve full employment?
10. What assumptions about wage rates and prices do your calculations presuppose?