1.THE AGGREGATE EXPENDITURE MODEL (IN THE SHORT RUN)

YOU MUST SHOW YOUR CALCULATIONS IN THE SPACE BELOW

FOR THE NEXT PROBLEM USE THE FOLLOWING FORMULA:

CHANGE IN GDP = [ 1 / (1-MPC)] * CHANGE IN G

Initially, the economy is producing $13 trillion in goods and services and the government is spending $2 trillion.

Then the government decides to increase its spending to $2.7 trillion. a) What is the value of the spending multiplier? (3 POINTS) b) Compute the new equilibrium level of output. (7 POINTS)

Assume that the marginal propensity to consume is 0.7 (MPC=0.7).

a)Multiplier=(1/(1-b))

Multiplier=3.33

b)(Y1-Y0)=(1/(1-b))*(G1-G0)

Y1=15.33 trillion