Reference no: EM13396628

Consider the following model

i) C = 1500 + mpc (Y - tY)

ii) I = 800

iii) G = 500

iv) X - M = 500 - mpi (Y)

where:

t = the (flat) tax rate

mpc = the marginal propensity to consume

mpi = the marginal propensity to import

suppose mpc = .80, t = .25, mpi = .2

a. solve for the equilibrium output

b. Solve for the (government) spending multiplier.

c. When we discussed the multiplier we discussed the impact effect.  For example, suppose that G increases by 100 to 600 and we assume, as we often do, that firms match the increase in demand by increasing Y by 100.  In round two, this is an increase in income of 100 to consumers. Trace out exactly where this 100 increase in income goes in the second round and compare to our simpler treatment with a closed economy and lump sum taxes. Hint, there are three leakages to address(again, please be very specific as to where the 100 increase income 'goes' in this second round).

d. What would happen to the multiplier if the mpi rises to .25.  Please explain the intuition.