1. ECON 2313
Solution to exercise 2
Part 1
a = 700
b = C/YD = 850/1000 = 0.85
C = YD = [(0.85)( )] = $4,666.66
C = b YD = 0.85 YD YD = - T =  C = (0.85)(-40) = -34

2. Figure 1
C (billions)
700
YD (billions)

3. Part 2
The multiplier is given by: 1/(1-b) = 1/(1-0.75)=1/0.25 = 4
The aggregate expenditure function is given by: AE = 600 – [(.75)(400)] + .75Y – 50 = Y
Use the following formula to solve for equilibrium GDP (Y)
Thus we have:

4. AE (billions) Figure 2 E 1550 450 6,200 Real GDP (billions)
AE = Y E
1550
450
6,200
Real GDP (billions)

5. 4. First we compute the change in equilibrium GDP (Y)
Note that: YD = Y = 200 Thus we have:
C = b YD = (0.75)(200) = $150
5. AE = Y.
Now we compute AE when Y = $6,500
AE = [(0.75)(6,500)] = $6425
Y > AE by 75; hence we have positive unplanned inventory investment equal to $75.

6. ’  Increase in government expenditure, ceteris paribus Panel A
AE (billions)
AE2 ’
AE1 
450 Y2 Y1
Real GDP (billions)

7. ’  Decrease in interest rates, ceteris paribus Panel B AE (billions)
450 Y2 Y1
Real GDP (billions)

8.  ’ ’ Stock market crash, ceteris paribus Panel C AE (billions) AE1
450 Y0 Y1
Real GDP (billions)

9.  ’ Increase in net taxes, ceteris paribus Panel D AE (billions) AE1
450 Y0 Y1
Real GDP (billions)

10. ’  Increase in exports, ceteris paribus Panel E AE (billions) AE2
450 Y2 Y1
Real GDP (billions)