1
$\begingroup$

So i have this question:enter image description here

I go along and get enter image description here

Then i need to calculate the effect on the optimal output is G increases by 80:enter image description here

And on the answer sheet it states that the spending multiplier is:

enter image description here

From my knowledge i know that enter image description here

Now how come that the spending multiplier is 1/0.4? Where are they getting the 0.4, which should be 1-c1-d1 from the original equations?

A friend told me that the 1/0.4 is derived from 1/1-c1(1-t)

then 1/1-0.8(0.75)= 1/0.4. He said that since there is no d1 in the equations ( in the investment equation) we don't use it.

Can somebody explain the meaning behind this 1/0.4) Thanks!

$\endgroup$
1
$\begingroup$

Your friend is right. If you look at the initial investment equation, and comparing it to your definition, you have: $$I=900+(0)Y-50i$$ So $d_{1}=0$ and $c_{1}=0.8(0.75)$ and thats why you get the spending multiplier as $\frac{1}{0.4}$

| improve this answer | |
$\endgroup$
  • $\begingroup$ but wouldn't c1 just be 0.8 and not 0.8 times 0.75? $\endgroup$ – Sara Saletti Jul 9 '19 at 11:50
  • 1
    $\begingroup$ $C=0.8(1-t)Y$ where $t$ is exogenously given. Further, if you look at your IS curve you derive, $c_1$ is that chunk that appears before $Y$. I believe it isn’t just the $0.8$ $\endgroup$ – Brennan Jul 9 '19 at 14:23
  • 1
    $\begingroup$ what does t being exogenous imply?? i didnt quite get it $\endgroup$ – Sara Saletti Jul 9 '19 at 16:37
  • 1
    $\begingroup$ It just means that it is computed outside of the model and should be taken as given. Its an assumption that simplifies the model. It is like assuming government expenditures, $G=800$ so it is easier to compute. Im sure you could dig deep into where $t$ comes from in reality. $\endgroup$ – Brennan Jul 9 '19 at 17:24

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.