# the effect on the marginal propensity to spend Question 1 Consider the following information about t

the effect on the marginal propensity to spend

Question 1

Consider the following information about the demand for

goods and services All variables are in billions of dollars

Consumption Function: C = 1000 + 09 YD

Investment Demand: I

= 1400

Government Purchases: G = 1500

Taxes: Ta = 1000 +

015 Y

Transfer Payments: Tr

= 1100

Exports: X

= 800

Imports: Imp = 1200

a Suppose that the potential level of output is $12,000

billion Use the above information to calculate the size of the output gap?the

actual level of output minus the potential level?if the economy is at

equilibrium, that is, the actual level of output is the equilibrium level Show

your work and illustrate the size of the output gap graphically with a

Keynesian cross diagram

b Calculate the size of the trade deficit or trade surplus

at equilibrium Be clear whether there is a deficit or a surplus

c Suppose that next year the economy reaches potential

output, that is,

the equilibrium level of output next year is $12,000

billion Calculate the magnitude of the exogenous change in aggregate demand

that is necessary to achieve this result Show your work

d Now assume that Imports also vary positively with income

such that

Imp = 1200 + 01Y

First, explain what will be the effect on the marginal

propensity to spend, that is, on the slope of the AD curve and illustrate

graphically

Second, explain what will be the effect on the multiplier

Be clear about the form of the multiplier and why it changes