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Suppose that for a particular economy, investment is equal to 200, government purchases are 150, net taxes (that is lump-sum taxes minus transfer) is 100 and consumption is given by C = 100 + 0.75y

(i) What is the level of equilibrium income?

(ii) Calculate the value of the government expenditure multiplier and the tax multiplier.

(iii) If the government expenditure increases by 200, find the change in equilibrium income.


Solution

Given,

I = 200

G = 150

T = 100

C = 100+0.75Y

¯C = 100

c = 0.75

(i) Equilibrium level of income

Y=11c(¯CcT+I+G)

=110.75(1000.75×100+200+150)

=10.25(375)

=37525×100=Rs.1500

(ii) Government expenditure multiplier

ΔYΔG=11c=110.75=10.25

= 125×100=4

Tax multiplier =ΔYΔT=c1c

0.7510.75=0.750.25=7525=3

(iii) New equilibrium income 

11c[¯CcT+I+G+ΔG]

=110.75[1000.75×100+200+150+200]

=10.25×575=57525×100=2300

Change in equilibrium income = 2300 - 1500 = Rs. 800.

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