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IAI Q31 confusion

D

dextar

Member
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!
 
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