Econ Reading 4 - Econ103 Macroeconomic Principles - Fall...

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Econ103 – Macroeconomic Principles - Fall 2010 – Professor: Werner Baer Reading4-p.1 Reading 4: Computing Equilibrium National Income Income Multiplier and Tax Multiplier Income multiplier = 1/(1-MPC) Tax multiplier = - MPC/(1-MPC) Example 1 (for equilibrium income, without taxes) Given C = 100 + 0.75*Y I = 50, G = 250 Y F = Y (full employment) =1,800 a) Find the equilibrium Y (GDP), consumption, and income multiplier. b ) What should the government do (in terms of fiscal policy) to make the economy achieve full employment? Solution: a) We know that GDP =Y = C + I + G. Thus: Y = 100 + 0.75*Y + 50 + 250 b Y = 400 + 0.75*Y b Y - 0.75*Y = 400 b 0.25*Y = 400 b Y = 400/0.25 = 1,600 Thus, C = 100 + 0.75*Y = 100 + 0.75*1,600 = 100 + 1,200 = 1,300 To find the multiplier, we need the marginal propensity to consume (MPC). The MPC is used in the consumption function (it is the coefficient of Y): C = C 0 + MPC*Y = 100 + 0.75*Y Thus, in this case, MPC = 0.75. Using the formula for income multiplier, we have: income multiplier = 1/(1-MPC) = 1/(1-0.75) = 1/0.25 = 4 b) Full employment income is Y F = 1,800, while equilibrium income is Y E = 1,600 (calculated above), thus the economy’s income need to increase Y by 200 to achieve full employment. The government can increase government
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This note was uploaded on 03/10/2011 for the course ECON 103 taught by Professor Staff during the Spring '08 term at University of Illinois, Urbana Champaign.

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Econ Reading 4 - Econ103 Macroeconomic Principles - Fall...

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