TUTORIAL 1- WEEK 3

Question 1:
Suppose that the economy is characterized by the
following behavioural equations:
C = 160 + 0.6 Y
D
I = 210
G = 150
T = 100 + 0.1 Y
Solve for :

a. Equilibrium GDP (Y)
The equilibrium condition is Y = C(YT)+I+G
Hence, Y = 160+0.6*(Y1000.1Y)+210+150
Y = 520+0.6Y600.06Y
0.46Y = 460
Y = 1000
Equilibrium GDP 1000
b. Disposable Income (Y
D
)
Y
D
= Y - T
=1000 - (100 + 0.1 * 1000)
=800
c. Consumption Spending (C)
Y
D
= 800
C = 160 + 0.6 Y
D

C = 160 + 0.6 (800)
= 640


d. Compute total demand. Is it equal to
production? Explain.
Total demand: Z = C + I + G = 640 + 210 + 150 = 1000
From part (a) equilibrium GDP(Y) = 1000
At equilibrium, total demand = production
Equilibrium in the goods market require production Y to be
equal to demand for goods Z
Y =Z (equilibrium condition)
Total demand: Z C + I + G , Y = C+ I + G
If firms hold inventories production does not equal demand
as firms can satisfy an demand through drawing upon
inventories (negative inventory investment). On the other
hand, firms can respond to demand by continuing
production + accumulating inventories positive
inventory investment.

e. Assume that Government Spending G is now equal
to 110. Solve for equilibrium output. Compute total
demand. Is it equal to production? Explain
Equilibrium output
Y= 160 +0.6(Y-100-0.1Y) + 210+110
Y = 913
Total Demand
Yd= 913-100-0.1x913 C= 160+0.6x722
= 722 = 593
Z = C + I + G
= 593 + 210 + 110
= 913
Therefore it is at equilibrium.

Equilibrium in the goods market
Z = Y = 913


f. Assume that Government Spending G is now equal
to 110, so output is given by e. Compute private plus
public saving. Is it equal to investment? Explain.
Private = Y T C
= 913- 191- 593
= 129
Public = T G
= 191 110
= 81
81+ 129 = 210 equals to investment
Investment = Savings

Equilibrium in the market for goods and services
Investment =Saving

g. What is the multiplier? What happens to the
multiplier if tax revenue (T) is instead fixed at 100?
Explain.
C = 160 + 0.6YD = 160 + 0.6(Y T)
Since T = 100 + 0.1Y
C = 160 + 0.6 [Y (100 + 0.1Y)]
= 160 + 0.6(Y 100 0.1Y)
= 160 + 0.6(0.9Y 100)
= 160 + 0.54Y 60
= 100 + 0.54Y
Y = C + I + G = 100 + 0.54Y + 210 + 110
= 420 + 0.54Y

So, the multiplier is 0.54.

If T is fixed at 100,
C = 160 + 0.6(Y 100)
= 160 + 0.6Y 60
= 100 + 0.6Y
Y = C + I + G = 100 + 0.6Y + 210 + 110
= 420 + 0.6Y

So, if T is fixed at 100, multiplier will change from
0.54 to 0.6