Problem
The following information is for questions (for each part, show your working). Consider an economy that comprises of the following:
a) The consumption function is C=200 + 0.9 (YD), where C is consumption expenditure and YD denotes disposable income
b) Taxes (T) = 0.2Y so YD = Y - 0.2Y = 0.8Y
c) Planned business investment, I = 100
d) Government expenditure, G = 100
e) Exports X = 200, imports M = 0.12Y, so net exports are: 200 - 0.12Y
Task
1. What is the aggregate expenditure (AE) function?
2. Using algebra, find equilibrium GDP (i.e. equilibrium national income Y).
3. Assume that full employment output for this economy is $1750 million. Based on equilibrium GDP you calculated above, by how much does equilibrium differ from full employment output?
4. What is the multiplier for the AE function above?
5. Based on the value of the multiplier, by how much should the Government increase spending to ensure that equilibrium GDP is equal to full employment output?