In the simple Keynesian model that does not have any government or foreign sectors, let’s say that the economy is in equilibrium at an output of $2 billion with an MPC of 0.9. If investment spending decreases by $.05 billion, what is the new equilibrium output level?
a) $2.50 billion
b) $1.90 billion
c) $1.95 billion
d) $1.50 billion
Ans
d) $1.50 billion
?Y/?I=1/(1-MPC)
?Y=?I/(1-MPC)
MPC=0.9
?I= -0.05
?Y= -0.05/(1-0.9) = -0.05/0.1= -0.5
2.0-0.5=1.5
——
According to the concept of mutiplier i.e. dY/dI = 1/1-MPC we get the value of multiplier “10″. Now it is very simple:
dY/dI = 10
dy = 10*dI
dY = 10*-.05
dy = -0.5
New equlibrium = Y + dY
= 2 - 0.5
New equlibrium = $1.50 billion