C = a + bY D is consumption function. Y D = C + S is identity. Classical theory assumes there will be full employment when economy is in equilibrium. MPC = C (consumption) / Y D (disposable income) or 8000 / 10,000 = 0.8 Equilibrium Condition: S = Des. I, S = 0.2Y - $400B, Des. I = $400B 0.2Y - $400B = $400B 0.2Y = $800B, Y E = $4000B Fed raises interest rate (i) b/c the Fed wanted to cause an upward movement along the desired investment demand curve. Increase in the productivity of capital = rightward (upward) shift of desired investment demand curve. Aggregate Expenditure (AE) @ Y F : AE = C + Des. I C = $150B + 0.9Y, Des. I = $200B = 150B + 0.9Y + 200B full employment level = Y F = $4000B = 350B + 0.9Y, AE@Y F = 350B + 0.9(4000), = 350B + 3600 = $3950B Undesired in inventories @ Y F : (leakages – injections) S = .1Y – 150B S = .1(4000) – 150B S = 250B S – Des. I = 250B - 200B = $50B Increase in autonomous desired spending needed to cause equilibrium of Y to = Y
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