Consider a closed economy to which the Keynesian-cross analysis applies.

Consumption is given by the equation C = 100 + 0.6*(Y – T).

Planned investment is 300, as are government spending and taxes.

a. If the current output is 1,400, what is planned consumption? What has planned expenditure?

b. What is inventory accumulation (i.e., unexpected increase in inventory) or decumulation (i.e., unexpected decrease in inventory)? Should equilibrium output be higher or lower than 1,400?

c. What is equilibrium output? What is equilibrium consumption?

d. Draw a Keynesian-cross model. Label the output level of 1,400 and the equilibrium output level, and the corresponding levels of planned expenditure.

e. What is government spending multiplier?

f. How much does equilibrium income decrease when government spending decreases from 300 to 100?

g. Suppose the natural rate of output is 1,600. By what percentage is the equilibrium output above or below the natural rate of output? According to the Okun’s law, how much is cyclical unemployment?

h. Should the government increase or decrease government spending to reach the natural rate of output? By how much?

i. Should the government raise or cut taxes to reach the natural rate of output?