The economy of Bananaland can be characterized by Equation 9.3.
EQUATION 9.3:
C = 2,000 + 0.75Yd
T = 200
G = 400
I = 500
-Refer to Equation 9.3.If government spending in Bananaland increases by $50,equilibrium output increases by

Question

Quizplus · Accepted Answer

The equation for equilibrium output in the economy of Bananaland is:

Y = C + I + G

Y = (2,000 + 0.75Yd) + 500 + 400
Y = 2,900 + 0.75Yd

To find the effect of a $50 increase in government spending, we need to determine the marginal propensity to consume (MPC), which is the fraction of each additional dollar of income that is spent on consumption. We can use the given equation for consumption:

C = 2,000 + 0.75Yd

To find Yd (disposable income), we subtract taxes from income:

Yd = Y - T

Substituting T = 200, we get:

Yd = Y - 200

Now we can solve for the MPC:

MPC = change in consumption / change in disposable income

MPC = (C1 - C0) / (Yd1 - Yd0)

We can assume that the $50 increase in government spending is financed by an equal increase in taxes, so there is no change in disposable income. Therefore, Yd1 = Yd0 and the MPC is simply the coefficient on Yd in the consumption equation:

MPC = 0.75

This means that for every additional dollar of disposable income, consumption will increase by $0.75. So a $50 increase in government spending will increase aggregate demand by:

$50 * (MPC + 1) = $50 * 1.75 = $87.50

This increase in aggregate demand will lead to an increase in equilibrium output:

change in Y = multiplier * change in demand

where the multiplier is:

multiplier = 1 / (1 - MPC)

multiplier = 1 / (1 - 0.75) = 4

So:

change in Y = 4 * $87.50 = $350

Therefore, equilibrium output will increase by $350, which is closest to answer B, $200.

The Economy of Bananaland Can Be Characterized by Equation 9