Chapter 11, Problem 1QQ

To determine

The equilibrium income.

Answer to Problem 1QQ

Option ‘d’ is the correct answer.

Explanation of Solution

Option (d):

The increases in equilibrium income due to an increase in government purchase can be calculated as follows:

First, calculate the government spending multiplier.

$\begin{array}{c}\text{The mulitiplier}=\frac{1}{\left(1-\text{MPC}\right)}\\ =\frac{1}{\left(1-\frac{2}{3}\right)}\\ =3\end{array}$

Therefore, the value of government spending multiplier is 3.

Now, the increase in equilibrium income due to an increase in government purchase can be calculated as follows:

$\begin{array}{c}\text{Changes in income}=\$120\times 3\\ =\$360\end{array}$

Therefore, the equilibrium income increases by $360 million.

Thus option (d) is correct.

Option (a):

The increases in equilibrium income due to an increase in government purchase can be calculated as follows:

First, calculate the government spending multiplier.

$\begin{array}{c}\text{The mulitiplier}=\frac{1}{\left(1-\text{MPC}\right)}\\ =\frac{1}{\left(1-\frac{2}{3}\right)}\\ =3\end{array}$

Therefore, the value of government spending multiplier is 3.

Now, the increase in equilibrium income due to an increase in government purchase can be calculated as follows:

$\begin{array}{c}\text{Changes in income}=\$120\times 3\\ =\$360\end{array}$

Therefore, the equilibrium income increases by $360 million.

Thus option (a) is incorrect.

Option (b):

The increases in equilibrium income due to an increase in government purchase can be calculated as follows:

First, calculate the government spending multiplier.

$\begin{array}{c}\text{The mulitiplier}=\frac{1}{\left(1-\text{MPC}\right)}\\ =\frac{1}{\left(1-\frac{2}{3}\right)}\\ =3\end{array}$

Therefore, the value of government spending multiplier is 3.

Now, the increase in equilibrium income due to an increase in government purchase can be calculated as follows:

$\begin{array}{c}\text{Changes in income}=\$120\times 3\\ =\$360\end{array}$

Therefore, the equilibrium income increases by $360 million.

Thus, option (b) is incorrect.

Option (c):

The increase in equilibrium income due to an increase in government purchase can be calculated as follows:

First, calculate the government spending multiplier.

$\begin{array}{c}\text{The mulitiplier}=\frac{1}{\left(1-\text{MPC}\right)}\\ =\frac{1}{\left(1-\frac{2}{3}\right)}\\ =3\end{array}$

Therefore, the value of government spending multiplier is 3.

Now, the increase in equilibrium income due to an increase in government purchase can be calculated as follows:

$\begin{array}{c}\text{Changes in income}=\$120\times 3\\ =\$360\end{array}$

Therefore, the equilibrium income increases by $360 million.

Thus option (c) is incorrect.

Economics Concept Introduction

Government spending multiplier: The government spending multiplier indicates the ratio of change in equilibrium income to the change in government spending.