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    Spending by Individuals, Firms, and Governments

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    Given the following variable in the open economy aggregate expenditure model, autonomous consumption (C0) = 200, autonomous investment (I0) =200, government spending (G0) = 100, export spending (X0) = 100, autonomous import spending (M0) = 100, taxes (T) = 0, marginal propensity to consume (c1) = 0.8, marginal propensity to invest (i1) = 0.1, and marginal propensity to import (m1) = 0.15,

    a.Calculate the equilibrium level of income for the open economy aggregate expenditure model.

    b.If there is an increase in autonomous import expenditure from 100 to 200 resulting from an increase in the currency exchange rate, calculate the new equilibrium level of income and the value of the multiplier.

    c.Compared with the original equilibrium in part a, if the government decides to impose taxes (T) of 100, calculate the new equilibrium level of income.

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    Solution Preview

    a. First we need to write the equation for calculating expenditure. Say the real GDP is Y, then we know that

    Y = C + I + G + X - M

    We now need to specify each component:

    C = C0 + MPC * (Y - T), since consumption is equal to autonomous consumption plus MPC * Disposable Income.
    I = I0 + MPI * (Y - T)
    G = ...

    Solution Summary

    Equilibrium expenditure is figured.