QUESTION 1

1. Calculate the MPS.

As, MPC = change in consumption/ change in income

In the figure consumption increase by 1000 and

income increased by 2000.

So, MPC = 1000/2000

MPC = 0.5

As, MPC+MPS = 1

Now, MPS = 1 – MPC

MPS= 0.5
 2. If Planned Investment increases for 400 what will be the equilibrium (show your calculation)?

As investments increase, firms increase their output and increase their payments for factors of
production. Households have a higher income and increase their consumption expenditure (c∆Y) and
their imports (m∆Y). Companies are increasing their production again to meet this increased demand,
which further increases household income.

As, according to the graph,

Consumption = 4500

Investment = 500

Govt Exp = 1000

If we increases 400 in investment, then

Equilibrium = C+I+G

= 4500+900+1000

= 6400

It means previous equilibrium of aggregate expenditure increases from 6000 units to 6400 units.

Question 2
1. Fill in the blanks. Find the equilibrium GDP.

Governme
nt Aggregate
GDP/ Consumpti Investme expenditu Export Impor Expenditu Inventori GDP
Income on nt re s ts re es will

9000 7400 1200 1000 400 600 10000 200 9800

10000 8200 600 1060

10800 200
1200 1000 400 0

11000 9000 1200 1000 400 600 11600 200 1140

 0

12000 9800 600 1220

12400 200
1200 1000 400 0

13000 10600 600 1300

13200 200
1200 1000 400 0

The equilibrium of the GDP is at 13000.

2. Calculate the MPC and the multiplier.

As, MPC = change in consumption/ change in income

Incom Change Consumption Change in

e in Consumption
income
9000 7400
10000 1000 8200 800
11000 1000 9000 800
12000 1000 9800 800
13000 1000 10600 800

MPC = 800/1000

MPC = 0.8

As, MPC + MPS = 1

MPS = 1- MPC

= 1-0.8

MPS = 0.2

The GDP added to the economy is the sum of all spending,

which has a larger effect than the dollar the government
originally spent. In other words, public spending is
"multiplied".

Multiplier = 1/(1-MPC). In the above example:

Multiplier = 1/(1-.8) = 1/(.2) = 5.  A greater MPC leads to a
larger multiplier.

The multiplier * the change in initial spending = change in

the economy’s total spending (GDP)

In the above example:

5 * $1,000 = $5,000

3. If the government wants to set a new equilibrium at 13000 by how much it needs to increase the government
expenditure?

If the new equilibrium is at 13000, the government expenditure will be same. There is no change in
government expenditure.