Suppose that for a particular economy, investment is equal to 200, government purchases are 150, net taxes (that is lump-sum taxes minus transfers) is 100 and consumption is given by C = 100 + 0.75Y (a) What is the level of equilibrium income? (b) Calculate the value of the government expenditure multiplier and the tax multiplier. (c) If government expenditure increases by 200, find the change in equilibrium income.
The level of equilibrium income is 1500.
Government expenditure multiplier = 4; Tax multiplier = -3
The change in equilibrium income is 800.
Explanation
This question tests the understanding of equilibrium income determination and fiscal policy multipliers in a simple Keynesian model. The consumption function C = 100 + 0.75Y indicates that autonomous consumption (C̄) is 100 and marginal propensity to consume (c) is 0.75. When taxes are present, the consumption function becomes C = C̄ + c(Y - T), where Y - T is disposable income. The equilibrium income formula from the context is Y* = 1/(1-c) × (C̄ - cT + cTR̄ + I + G). The government expenditure multiplier shows how much income changes for a unit change in government spending, while the tax multiplier captures the impact of tax changes on equilibrium income.