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Changes in Equilibrium GDP .
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Explanation of Solution
Table -1
(1) Real domestic output |
(2) Aggregate expenditure, private closed economy |
(3) Export (in billions) |
(4) Import (in billions) |
(5) Net export (in billions) Private closed economy |
(6) Aggregate Expenditure (in billions), open economy |
$200 | $240 | $20 | $30 | -$10 | $230 |
$250 | $280 | $20 | $30 | -$10 | $270 |
$300 | $320 | $20 | $30 | -$10 | $310 |
$350 | $360 | $20 | $30 | -$10 | $350 |
$400 | $400 | $20 | $30 | -$10 | $390 |
$450 | $440 | $20 | $30 | -$10 | $430 |
$500 | $480 | $20 | $30 | -$10 | $470 |
$550 | $500 | $20 | $30 | -$10 | $510 |
The net export can be calculated by using the following formula.
Substitute the respective values in Equation (1) to calculate the net export at the real output $200.
The net export is -$10 billion.
The aggregate expenditure (AE) of open economy can be calculated by using the following formula.
Substitute the respective values in Equation (1) to calculate the aggregate expenditure at the real output $200.
The aggregate expenditure of open economy is $230 billion.
Table -2 shows the value of net export and aggregate expenditure of open economy that obtained by using equation (1) and (2).
Table -1
(1) Real domestic output |
(2) Aggregate expenditure, private closed economy |
(3) Export (in billions) |
(4) Import (in billions) |
(5) Net export (in billions) Private closed economy |
(6) Aggregate Expenditure (in billions), open economy |
$200 | $240 | $20 | $30 | -$10 | $230 |
$250 | $280 | $20 | $30 | -$10 | $270 |
$300 | $320 | $20 | $30 | -$10 | $310 |
$350 | $360 | $20 | $30 | -$10 | $350 |
$400 | $400 | $20 | $30 | -$10 | $390 |
$450 | $440 | $20 | $30 | -$10 | $430 |
$500 | $480 | $20 | $30 | -$10 | $470 |
$550 | $500 | $20 | $30 | -$10 | $510 |
Multiplier can be calculated as follows.
The multiplier is 5.
Given the multiplier, the marginal propensity to consume (MPC) is calculated as follows,
The marginal propensity to consume is 0.8.
From table 1, before the addition of government expenditure (G), the open private sector equilibrium is at $350 billion.
When the government expenditure of $20 billion is added, the AE increases and increases the equilibrium level of GDP. Due to the multiplier effect, the equilibrium GDP increases by $100 billion
Whereas, the $20 billion increase in taxes initially reduces consumption by $16 billion
Thus, the net change from this balance between the government spending and taxes is $20 billion
Concept Introduction:
Aggregate Expenditure (AE): It is the total value of spending in the economy during a period of time at given price level.
Equilibrium gross domestic product (GDP): Equilibrium GDP occurs at the point where the aggregate expenditure equals to the real domestic output.
Multiplier effect: It describes how an injection to the economy via increase in government spending, investment spending, consumer spending and so forth create a ripple effect in the real output (increase) of the economy.
Marginal Propensity to Consume (MPC): It measures the amount of disposable income that consumers are willing to spend on goods and services.
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