Consider a closed economy in which the marginal propensity to consume is 0.50. a. What is the spending multiplier for this economy (AY*/AE,)? b. All else equal, how would autonomous expenditure be affected (up or down, and by how much) by a 200 unit increase in government purchases? How would the equilibrium value of income be affected? c. All else equal, how would autonomous expenditure be affected (up or down, and by how much) by a 200 unit increase in taxes (T)? How would the equilibrium value of income be affected? d. All else equal, how would autonomous expenditure be affected (up or down, and by how much) by simultaneous 200 unit increases in taxes (T) and government purchases (G)? How would the equilibrium value of income be affected?

a) The spending multiplier will be = 1/ MPS

MPS (marginal propensity to save) = 1 - MPC

MPS = 1- 0.50

MPS= 0.50

The spending multiplier= 1/0.50

The spending multiplier = 2

b) The components of autonomous expenditure are consumption, investment and government purchases. If a government purchase rises by 200 units then autonomous expenditure rises by the same amount. It will affect the constant part hence the coefficient will rise, and the curve will shift upward.

To maintain the goods market equilibrium, Y must equal to the autonomous expenditure. When autonomous expenditure rises then it will affect income positively and income will rise.

c) Tax is a component of consumption function; it will affect the slope of the consumption function. If tax increases then people's disposable income will fall so the consumption will fall by the same amount. Then it will affect the autonomous expenditure curve, so it will also fall and shifts downward direction. Hence the income will fall than before.

d) If the change in government purchase and the taxes is same then the situation is called a balanced budget. At this situation the revenue of the government and the expenditure are same so the economy is in an equilibrium condition. At this condition, neither of any curves will shift and the income will be unaffected.