Consider two hypothetical economies that are perfectly similar except for their marginal propensity to consume (MPC). Each economy is currently in equilibrium with real income and planned expenditure equal to $100 billion, as given by the black points (plus signs) on the following two graphs. Assume that both economies are closed to trade, and that neither economy has taxes that change with income. The graphs also plot the 45-degree line. The first economy has an MPC equal to 0.5. Therefore, its initial planned expenditure line has a slope of 0.5 and passes through the point (100, 100). The second economy has an MPC equal to 0.75. Therefore, its initial planned expenditure line has a slope of 0.75 and passes through the point (100, 100). Now, suppose there is an increase of $20 billion in planned investment in each economy. In the first economy (with MPC = 0.5), the $20 billion increase in planned investment causes equilibrium income to increase by billion. In the second economy (with MPC = 0.75), the $20 billion increase in planned investment causes equilibrium income to increase by billion. Therefore, a higher MPC is associated with a multiplier. Now, confirm your graphical analysis algebraically using the formula for the multiplier: Multiplier = 11−MPC For the first economy with an MPC of 0.5, the effect of the $20 billion increase in planned investment becomes the following: Change in Equilibrium Real Income = Change in Planned Expenditure × Multiplier = × = × = Using the same method, the multiplier for the second economy is

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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Consider two hypothetical economies that are perfectly similar except for their marginal propensity to consume (MPC). Each economy is currently in equilibrium with real income and planned expenditure equal to $100 billion, as given by the black points (plus signs) on the following two graphs. Assume that both economies are closed to trade, and that neither economy has taxes that change with income. The graphs also plot the 45-degree line.

The first economy has an MPC equal to 0.5. Therefore, its initial planned expenditure line has a slope of 0.5 and passes through the point (100, 100).

The second economy has an MPC equal to 0.75. Therefore, its initial planned expenditure line has a slope of 0.75 and passes through the point (100, 100).

Now, suppose there is an increase of $20 billion in planned investment in each economy.

In the first economy (with MPC = 0.5), the $20 billion increase in planned investment causes equilibrium income to increase by

billion. In the second economy (with MPC = 0.75), the $20 billion increase in planned investment causes equilibrium income to increase by

billion. Therefore, a higher MPC is associated with a multiplier.

Now, confirm your graphical analysis algebraically using the formula for the multiplier:

Multiplier

11−MPC

For the first economy with an MPC of 0.5, the effect of the $20 billion increase in planned investment becomes the following:

Change in Equilibrium Real Income	=	Change in Planned Expenditure	×	Multiplier
	=		×
	=		×
	=

Using the same method, the multiplier for the second economy is .

**Instructions:**
Place a green line (triangle symbol) on each of the preceding graphs to indicate the new planned expenditure line for each economy. Then place a black point (plus symbol) on each graph showing the new level of equilibrium income. *(Hint: You can see the slope and vertical axis intercept of a line on the graph by selecting it.)*

**Graph Details:**

- **Title:** MPC = 0.5
- **Axes:**
- **Horizontal Axis:** Real Income (Billions of dollars), ranging from 0 to 200.
- **Vertical Axis:** Planned Expenditure (Billions of dollars), ranging from 0 to 200.

- **Lines:**
- **45-Degree Line:** Depicted in black, representing where planned expenditure equals real income.
- **AE Line:** Depicted in blue, representing the aggregate expenditure line.

- The intersection of the AE Line and the 45-Degree Line marks the equilibrium point, shown by dashed black lines connecting to the axes.

- **Legend:**
- **New AE Line:** Indicated with a green triangle symbol.
- **New Equilibrium:** Indicated with a black plus symbol.

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