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IAI Actuarial Core Principles · Business Economics · Business activity, unemployment and inflation

In a simple Keynesian model, consumption is C = 200 + 0.8(Y − T), with lump-sum tax T = 250 (rupees crore), planned investment I = 300 and government spending G = 350. Net exports are zero. What is the equilibrium level of national income, in rupees crore, and what is the effect on it of raising G by 50?

Equilibrium income is 3,250 crore, found from Y = 0.8Y + 650. The government spending multiplier is 1 divided by 0.2, which equals 5, so a 50 crore rise in government spending lifts income by 250 crore.

  1. AEquilibrium income is 3,250; income rises by 250Correct
  2. BEquilibrium income is 3,250; income rises by 50
  3. CEquilibrium income is 2,250; income rises by 250
  4. DEquilibrium income is 3,250; income rises by 200
  5. Equilibrium income is 4,000; income rises by 250

Explanation

Y = 200 + 0.8(Y − 250) + 300 + 350 = 650 + 0.8Y, wait: 200 − 200 = 0, so Y = 0.8Y + 650, giving 0.2Y = 650 and Y = 3,250. The multiplier is 1/(1 − 0.8) = 5, so ΔG = 50 raises Y by 250. Choosing 50 ignores the multiplier.

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