Assume the economy is closed and there is no government. The aggregate demand components are described below:C = 100 + 0.6Y (1)I = 200 (2)There is a boost in investment making total investment now 300. What would happen if the marginal propensity to consume increases to 0.8? What is the consumption of equilibrium?
Question
Assume the economy is closed and there is no government. The aggregate demand components are described below:C = 100 + 0.6Y (1)I = 200 (2)There is a boost in investment making total investment now 300. What would happen if the marginal propensity to consume increases to 0.8? What is the consumption of equilibrium?
Solution
In a closed economy with no government, the aggregate demand (AD) is the sum of consumption (C) and investment (I). The initial equations are:
C = 100 + 0.6Y (1) I = 200 (2)
The aggregate demand (AD) is therefore AD = C + I = Y.
Substituting the equations (1) and (2) into the AD equation, we get:
Y = 100 + 0.6Y + 200 0.4Y = 300 Y = 750
This is the initial equilibrium level of income.
Now, investment increases to 300 and the marginal propensity to consume increases to 0.8. The new equations are:
C = 100 + 0.8Y (3) I = 300 (4)
Substituting the equations (3) and (4) into the AD equation, we get:
Y = 100 + 0.8Y + 300 0.2Y = 400 Y = 2000
This is the new equilibrium level of income.
The consumption at equilibrium is calculated by substituting Y = 2000 into equation (3):
C = 100 + 0.8*2000 C = 100 + 1600 C = 1700
So, the consumption at equilibrium is 1700.
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