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    government spending multiplier

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    Consider a closed economy, with fixed prices, represented by the following set of equations:

    D = C + I + G
    C = cYd
    Yd = (1 - t)Y
    t = 0.25, c = 0.8
    I = 700 - 100r
    G = 300
    L = 2500 + 2Y - 500r

    Where, D is the aggregate demand, C is consumption, Yd is the disposable income, t is the tax rate, I is investment, r is the interest rate (measured as a %), G is government spending and L is money demand.

    (a) Let the government pursue an interest rate target of 7%. How does it achieve this target? Hence determine the equilibrium level of income Y, the government surplus tY-G and the private sector surplus (1-c) Yd - I. Comment on why D = Y in equilibrium.
    (b) Using the same data, calculate the effects of increasing G to 400.
    (c) Now let the government pursue a policy of holding the money supply constant at 500, and spending G = 300. What will be the level of income and the rate of interest?
    (d) Using the above data, and continue to pursue a fixed money supply target of 500, recalculate your result when government spending increases to G = 400. Comment on the effects, of monetary factors, on the government spending multiplier.

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    https://brainmass.com/economics/aggregate-demand-and-supply/government-spending-multiplier-40637

    Solution Preview

    Consider a closed economy, with fixed prices, represented by the following set of equations:
    D = C + I + G
    C = cYd
    Yd = (1 - t)Y
    t = 0.25, c = 0.8
    I = 700 - 100r
    G = 300
    L = 2500 + 2Y - 500r

    Where, D is the aggregate demand, C is consumption, Yd is the disposable income, t is the tax rate, I is investment, r is the interest rate (measured as a %), G is government spending and L is money demand.
    (a) Let the government pursue an interest rate target of 7%. How does it achieve this target? Hence determine the equilibrium level of income Y, the government surplus tY-G and the private sector surplus (1-c) Yd - I. Comment on why D = Y in equilibrium.

    When r = 7%,
    I = 700 - ...

    Solution Summary

    The government spending multiplier is found.

    $2.19