In the aggregate demand framework, consumption function is given by C=100+0.8Yd where Yd is the disposable income. Suppose there are no taxes in this economy so Y=Yd. Investment level is Rs 50 and government expenditure is Rs 50. What is the level of saving in the economy in the equilibrium state? I'm not convinced about the solution. I approached it like this in equilibrium Y=AD Y=Cd + W =Cd+J => Cd+ S +T+I =Cd+ I +G +X Since exports and imports are 0 and taxes are 0 S=I+G =50+50 =100 Any problems here? Solution says S=50 what is the problem in this approach?
This is a strange question in that G=50 and yet T=0. How does the government finance its expenditure??? However, assuming that G=50, I=50, and that X=M=T=0, your method is fine and I agree with your answer of 100. Alternatively, the equilibrium income could be found by setting AggD=Y, where AggD=C+I+G+X-M = 100+0.8Y+50+50 = 200+0.8Y. Setting this equal to Y gives an equilibrium income of 1,000. Since C=100+0.8Y, S=Y-C=Y-(100+0.8Y)= -100+0.2Y, so when Y=1,000, S= 100.
Thanks Margaret for attempting this . This is ths part of solution given by them Y=C+I+G= Aggregate demand Y=100+0.8Y+50+50 Therefore, Y= (200/0.2)= Rs 1000 Saving in the economy= Income – Expenditures in the economy We know from a) that income is Rs 1000 Expenditure=Consumption expenditure plus government expenditure = 100 + 0.8*1000 + 50 = 950 Therefore, Saving= 1000 – 950 = Rs 50 However, I don't agree with the line marked with yellow why are we additing another 50?
I'm not sure what they're saying on the yellow line! Total expenditure at equilibrium is C+I+G= 100 +0.8(1000)+50 +50 = 1000. Consumer expenditure at equilibrium C = 100 +0.8(1000)=900. Savings is defined as that part of disposable income that is not spent, ie S =Yd-C, which in this case, since there are no taxes, = Y-C = -100+0.2Y, so at equilibrium, S=-100+0.2(1000) = 100 or more simply, S= Y-C= 1000-900=100. Alternatively, as you did, you can say that at equilibrium, planned injections equal planned withdrawals, ie S+T+M=I+G+X, ie S+0+0 = 50+50+0, so S=100. Whichever way you do it, the answer is 100!
