The total expenditure schedule in Macroland begins with these initial levels (in billions of dollars): Income = 1,000; Consumption = 900; Investment = 200; Government = 300; Net Exports = ?100. If the MPC = 0.75 and income increases in increments of 200, find the equilibrium level of income. If full employment requires an income level of 2,000, what (if anything) should the government do? Indicate both the direction of the spending change and the size of the spending change.
What will be an ideal response?
Initially, total expenditures equal 1,300 when income equals 1,000. Therefore, equilibrium income will be higher (excess expenditures exist at the 1,000 income level). Each $200 increase in income results in a $150 increase in expenditures ($200 × the MPC of 0.75). At an income of $2,200, consumption is $1,800 and total expenditures are $2,200. If full employment income is $2,000, then an inflationary gap exists and expenditures must be cut. By trial and error, it can be calculated that government spending must be cut from $300 by $50 to $250. At the full employment level of income of $2,000, Consumption will be $1,650, Investment = 200, Government = $250, and Net Exports = ?$100.
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