Reference no: EM13199579
Consider the following model of a closed economy (Smallville):
MPC = 0.8 - 0.01Y (marginal propensity to consume)
C = MPC x YD (consumption function)
YD = (Y - T) (disposable income)
I = 500 (investment spending)
G = 1,500 (government spending)
Y = AD (equilibrium condition)
T = 1,200 (taxes - non-income)
1. Find the equilibrium level of real GDP for Smallville. Note: you will have to solve a quadratic equation - and GDP cannot be negative, for obvious reasons.
2. What is value of the multiplier?
3. You can see that Smallville is running a budget deficit. Two policy programs are proposed: (1) eliminate the deficit by cutting government spending and (2) eliminate the deficit but raising taxes. Which program has the least damaging effect on GDP? (Just tell me how much GDP falls in each program and draw the correct conclusion.)
4. What is the multiplier associated with each policy program (i.e. the multiplier AFTER the program is implemented - just the number please)? Which policy program promotes economic stability?
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