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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!

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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 $\frac{1}{0.4}$

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  • $\begingroup$ but wouldn't c1 just be 0.8 and not 0.8 times 0.75? $\endgroup$
    – Sara Saletti
    Jul 9, 2019 at 11:50
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    $\begingroup$ $C=0.8(1-t)Y$ 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, 2019 at 14:23
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    $\begingroup$ what does t being exogenous imply?? i didnt quite get it $\endgroup$
    – Sara Saletti
    Jul 9, 2019 at 16:37
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    $\begingroup$ 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, 2019 at 17:24

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