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Consider the following model i) C = 1650 + mpc (Y - tY) ii) I = 800 iii) G = 500 iv) X - M = 500 - mpi (Y) where:
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Consider the following model i) C = 1650 + 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 = .60, t = .15, mpi = .2


a. Given the information above, solve for the equilibrium output:


b. We know that the formula for the (government) spending multiplier is 1/(1-[mpc(1-t) - mpi]). The value of the government spending multiplier in this problem is:


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. We will trace out exactly where this 100 increase in income goes in the second round. Recall, there are three leakages to address (via taxes, imports and savings).


Given that t=.15, we know that .15 of every dollar increase in gross income is a leakage due to taxes. Since the increase in income is $100, we know the leakage due to taxes is:


d. Given that mpi=.2, we know that .2 of every dollar increase in gross income is a leakage due to imports. Since the increase in income is $100, we know the leakage due to imports is:


e. Given that the MPC=.6, we know that .4 of every dollar increase in gross income is saved. Since the increase in income is $100, we know the leakage due to savings is:


f. What would happen to the multiplier if the mpi rises to .25? Round to 2 decimal places.


g. What would happen to the size of the leakage if the mpi rises to .25?

Step-by-step answer

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