Question

Answer the following questions, which relate to the aggregate expenditures model:

1. If Ca is \(100, Ig is \)50, Xn is −\(10, and G is \)30, what is the economy’s equilibrium GDP?

2. If real GDP in an economy is currently \(200, Ca is \)100, Ig is \(50, Xn is −\)10, and G is \(30, will the economy’s real GDP rise, fall, or stay the same?

3. Suppose that full-employment (and full-capacity) output in an economy is \)200. If Ca is \(150, Ig is \)50, Xn is −\(10, and G is \)30, what will be the macroeconomic result?

Short answer

1. The economy’s equilibrium GDP is $170.

2. The economy’s real GDP will fall.

3. There will be an inflationary expenditure gap in the economy.

Step-by-step solution

Step 1. Explanation for part (a)

The equation for equilibrium GDP is Y = C_a + I_g + X_n + G

Placing the respective values in the equilibrium equation as follows:

Y = $100 + $50 - $10 + $30

Y = $170

Therefore, the economy’s equilibrium GDP is $170.

Step 2. Explanation for part (b)

C_a = $100

I_g = $50

X_n = -$10

G = $30

Placing the values of expenditure components in the equilibrium equation:

Total Spending = $100 + $50 - $10 + $30

Total Spending = $170

The real GDP in the economy is $200, and the total spending is $170.

Since the real GDP is greater than the total spending GDP, the output or the real GDP will decline until the economy reaches an equilibrium.

Step 3. Explanation for part (c)

C_a = $150

I_g = $50

X_n = -$10

G = $30

Placing the values in the equation for equilibrium condition:

Y = $150 + $50 - $10 + 30

Y = $220

The full employment income is $200, the actual GDP ($220) is more than the potential GDP. It will cause an inflationary expenditure gap which can be reduced by slowing down or reducing production.