Question 4 [6 points]

Suppose a simple economy has no government, so that the aggregate expenditure function is: AE = C + I + X - IM where X = 50 and IM = 50 + 0.3Y.

The following graph is the United Kingdom's consumption schedule and the amount of investment is $60 billion.

a)Plot the aggregate expenditures and the equilibrium point.

b)What is the equilibrium GDP?

Equilibrium GDP = $

300

billion

Marking:

a)

Aggregate Expenditures

Your line is close to the correct slope, but these points from your answer are not on the correct line: (320, 300)

To plot the AE line we must first determine what the equation of the AE line is. To do this we need all of its components. We know the equation is given by AE = C + I + X - IM and we have I = 60, X = 50 and IM = 50 + 0.3Y, but we do not know the equation of the consumption schedule (C).

To solve for C we use the formula C = C₀+ cY. C₀is the vertical intercept of the consumption line which is 180. The slope (c) is found by using the standard formula for finding the slope of a line (ie. rise/run). In our case c = 0.5, so our consumption schedule equation is C = 180 + 0.5Y.

Substituting all the components into the AE equation:

AE=C + I + X - IM=(180 + 0.5Y) + (60) + (50) - (50 + 0.3Y)=240 + 0.2Y

Now we can plot the AE line by picking two different values for Y and solving for the corresponding AE value.

You will lose 1 mark for this part.

Equilibrium Point

Your answer is correct.

b)

Your answer was:$300 billion

Congratulations! You have entered the correct answer.

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Total marks for this question: 5