Assume that the consumption schedule for a private open...

Assume that the consumption schedule for a private open economy is such that consumption $C=50+0.8 Y$. Assume further that planned investment $I_{g}$ and net exports $X_{n}$ are independent of the level of real GDP and constant at $I_{g}=30$ and $X_{n}=10 .$ Recall also that, in equilibrium, the real output produced $(Y)$ is equal to aggregate expenditures: $Y=C+I_{g}+X_{n} .$ a. Calculate the equilibrium level of income or real GDP for this economy. b. What happens to equilibrium $Y$ if $I_{g}$ changes to 10 ? What does this outcome reveal about the size of the multiplier?

Assume that the consumption schedule for a private open economy is such that consumption $C=50+0.8 Y$. Assume further that planned investment $I_{g}$ and net exports $X_{n}$ are independent of the level of real GDP and constant at $I_{g}=30$ and $X_{n}=10 .$ Recall also that, in equilibrium, the real output produced $(Y)$ is equal to aggregate expenditures: $Y=C+I_{g}+X_{n} .$
a. Calculate the equilibrium level of income or real GDP for this economy.
b. What happens to equilibrium $Y$ if $I_{g}$ changes to 10 ? What does this outcome reveal about the size of the multiplier?

Key Concepts

Autonomous Spending

Autonomous spending refers to the components of aggregate expenditure that do not depend on the current level of income, such as fixed investment, government spending, and net exports. Changes in autonomous spending have a direct impact on aggregate demand and, through the multiplier effect, can lead to significant changes in equilibrium income.

Aggregate Expenditure Model

This model explains that an economy’s total output (or income) is determined by the sum of spending on consumption, investment, government spending, and net exports. It forms the basis of Keynesian analysis by stating that in equilibrium, the total production of goods and services is equal to aggregate expenditures, highlighting the role of demand in driving economic activity.

Consumption Function

The consumption function describes the relationship between total consumption and total income in an economy, typically expressed as the sum of autonomous consumption (spending that does not depend on income) and a portion of income that is spent (the marginal propensity to consume). This function is key to understanding how changes in income affect consumer spending and overall demand.

Keynesian Equilibrium

In the Keynesian framework, equilibrium is achieved when total production (real GDP) equals total spending (aggregate expenditure). This condition underlines the idea that output adjusts to meet demand and that shifts in components of aggregate spending can lead to changes in overall income and output.

Multiplier Effect

The multiplier effect is the process by which an initial change in autonomous spending leads to a larger change in aggregate income. It occurs because an initial increase in spending raises incomes for some, which then generates further rounds of spending, magnifying the overall impact on economic output. The size of the multiplier depends inversely on the marginal propensity to save (or directly on the marginal propensity to consume).

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