(Advanced analysis) In a private closed economy, (a) the marginal propensity to save is 0.25, (b) consumption equals income at $120 billion, and (c) the level of investment is $40 billion. What is the
Equilibrium level of income?
A) $280 billion
B) $320 billion
C) $262 billion
D) $198 billion

Question

Quizplus · Accepted Answer

The equilibrium level of income in a private closed economy is determined by the formula Y = C + I, where Y is the equilibrium income, C is consumption, and I is investment. Given that the marginal propensity to save (MPS) is 0.25, the marginal propensity to consume (MPC) is 1 - MPS = 0.75. Since consumption equals income at $120 billion when there are no savings, and investment is $40 billion, the equilibrium level of income can be calculated as follows: Since consumption equals income at a certain point and investment is added to determine total output or income, we adjust the formula to account for the given investment level. The equilibrium income (Y) is thus the sum of consumption at the break-even point plus the investment, which leads to Y = $120 billion + $40 billion = $160 billion. However, this calculation does not directly apply the given MPC or MPS in a straightforward manner, and the correct approach involves understanding that in equilibrium, savings equals investment. Given MPS is 0.25, and investment is $40 billion, we can infer that savings must also be $40 billion to be in equilibrium (since in a closed economy without government, S = I for equilibrium). To find the equilibrium level of income, we use the formula for savings: S = -C0 + MPS*Y, where C0 is autonomous consumption (consumption when income is zero), and Y is the income level. However, without direct information on autonomous consumption or a clear way to apply MPS directly from the information given, the equilibrium level of income is more accurately determined by understanding the relationship between savings, investment, and income rather than applying the MPS or MPC directly in this context. The correct calculation involves recognizing that the equilibrium condition in a closed economy without government intervention is where planned investment equals savings. Given the MPS and the level of investment, we can calculate the required savings to match this investment, and from there, deduce the total income. However, the initial explanation mistakenly simplified the relationship and did not accurately apply the economic principles to reach the correct answer based on the information provided. The correct answer involves a deeper analysis of the relationship between savings, investment, and the multiplier effect in determining the equilibrium level of income, which was not fully captured in the initial explanation.

(Advanced Analysis) in a Private Closed Economy, (A) the Marginal