GDP=500
Government spending decreases by 20
Taxes increase by 20
Investment decreases by 20
MPC=.8
What is the new equilibrium GDP?
The new equilibrium GDP would be 460. The equation for calculating the new equilibrium GDP is GDP = Government Spending + Investment + Taxes x MPC. Therefore, the new equilibrium GDP would be 500 - 20 - 20 + 20 x 0.8 = 460.
To find the new equilibrium GDP, we need to make adjustments to the initial GDP by taking into account the changes in government spending, taxes, and investment.
1. We start with the initial GDP of 500.
2. Government spending decreases by 20. So, we subtract 20 from the initial GDP: 500 - 20 = 480.
3. Taxes increase by 20. Since the marginal propensity to consume (MPC) is 0.8, which indicates that on average, 80% of any increase in income is spent, we can calculate the increase in income resulting from the tax increase. The increase in income is calculated as: (20 / (1 - MPC)).
Using the formula gives us: (20 / (1 - 0.8)) = 100.
Therefore, the new GDP after the tax increase is 480 + 100 = 580.
4. Investment decreases by 20. So, we subtract 20 from the new GDP: 580 - 20 = 560.
Therefore, the new equilibrium GDP is 560.
To calculate the new equilibrium GDP, we first need to understand the concept of the multiplier effect. The multiplier effect refers to the idea that changes in spending or investment can lead to larger changes in GDP. The multiplier is calculated using the formula:
Multiplier = 1 / (1 - MPC)
where MPC represents the marginal propensity to consume, which is the portion of additional income that people choose to spend. In this case, the MPC is given as 0.8, so we can calculate the multiplier as:
Multiplier = 1 / (1 - 0.8)
= 1 / 0.2
= 5
Now let's break down the changes in government spending, taxes, and investment:
1. Government spending decreases by 20. Since the government spending is a component of GDP, this decrease in spending will have a multiplier effect on the overall GDP. We can calculate the impact of the change in government spending by multiplying the initial change by the multiplier:
Change in GDP due to government spending = -20 * Multiplier
= -20 * 5
= -100
2. Taxes increase by 20. Since taxes reduce disposable income and people may save a portion of the increase in taxes, we need to account for the decrease in consumption. The change in consumption can be calculated as the difference between the change in taxes (20) and the portion saved (1 - MPC):
Change in consumption = Change in taxes - (1 - MPC)
= 20 - (1 - 0.8)
= 20 - 0.2
= 19.8
Similarly, we can calculate the impact on GDP due to the change in taxes by multiplying the change by the multiplier:
Change in GDP due to taxes = Change in consumption * Multiplier
= 19.8 * 5
= 99
3. Investment decreases by 20. Similar to government spending, investment is also a component of GDP, so a decrease in investment would have a multiplier effect as well:
Change in GDP due to investment = -20 * Multiplier
= -20 * 5
= -100
To find the new equilibrium GDP, we need to add up the changes in GDP due to the changes in government spending, taxes, and investment:
New equilibrium GDP = Initial GDP + Change in GDP due to government spending + Change in GDP due to taxes + Change in GDP due to investment
Given the initial GDP of 500, we can substitute the values:
New equilibrium GDP = 500 + (-100) + 99 + (-100)
= 299
Therefore, the new equilibrium GDP after the given changes is 299.