Question

Consider the following diagram, which depicts a country with no government expenditure, taxes, or net exports. Answer the following questions and explain your responses using the information in the diagram.

a. What is the marginal saving propensity?

a. What is the current level of projected investment spending over the next few years?

c. What is the current period's equilibrium level of real GDP?

d. What is the current period's saving equilibrium level?

e. What will the change in equilibrium real GDP be if planned investment spending for the current period is increased by$\$25$billion? What will the new real GDP equilibrium level be if all other variables, including the price level, remain constant?

Short answer

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Step-by-step solution

Disposable income

The margin of change in savings due to a change in disposable income is referred to as the marginal propensity to save (MPS). The ratio of change in consumption owing to change in disposable income is known as marginal propensity to consume.

The following is the link between MPS and MPC:

The relationship between MPS and MPC is given below:

$\text{MPS}=1-\text{MPC}$

Step 2  General equation

a) the general equation of consumption function is as follow.

$C=a+bY$

Here,

$a$is the autonomous consumption

$b$is the MPC

$C$is consumption

$\mathrm{Y}$is disposable income.

As per the diagram, at $\$4$trillions of income level, consumption is equal to$\$3.5$trillion and the autonomous consumption is $0.5$which is consumption at 0 level of income.

Substitute the value in consumption equation to get the MPC:

$C=a+bY$

$3.5=0.5+b\times 4$

$3.5-0.5=4b$

$b=\frac{3}{4}$

$=0.75$

Thus, the MPC is $0.75$.

Now, calculate the MPS:

$MPS=1-0.75$

$=0.25$

Thus, the MPS is $0.25$.

  Equalibrium level

$b$)

The equilibrium level of real GDP is attained where nation income($Y)$is equal to the aggregate expenditure $(C+1)$.

localid="1651559945121" $Y=AE$

localid="1651559941044" $=C+I$

Table of consumption, investment, and saving:

Level of real GDP

Thus, the equilibrium level of real GDP is $\$4$trillion.

Period of income level

c)

The general equation of savings is $S=-a+(1-b) Y$.

$a$is the autonomous consumption

$b$is the MPC

$(1-b)$is MPS

$S$is savings

$\mathrm{Y}$is disposable income.

At present period income level is $\$4$trillion MPS is $0.25$and a is $0.5$. substitute the values in saving equation: