Inflationary, Recessionary and Multiplier

19 11 2009

Problems:

(1)

(2)

(3)

Possible levels of employment(million) Real domestic output(billion) AE = Ca + Ig + Xn + G(billion)
45 Kd 250 Kd 260
50 Kd 275 Kd 280
55 Kd 300 Kd 300
60 Kd 325 Kd 320
65 Kd 350 Kd 340

a)      If full employment in this economy is 65 million, there will be an inflationary gap because the previous (normal) equilibrium happened when the possible levels of employment is at 55 million, but the current possible levels of employment  is at 65 million. So the consequence of this gap is the possible levels of employment increases from kd  55 million to kd 65 million (the gap is kd 10 million). The value of aggregate expenditure in column 3 which have to change at each level of GDP to eliminate the inflationary gap is kd 300 million – kd 340 million = -40 million

b)      If the real domestic output is kd 250 billion, there will be a recessionary gap because the previous (normal) equilibrium happened when the possible levels of employment is at kd 55 million, but the current possible levels of employment is  at kd 45 million, so the consequence of this gap is the possible levels of employment decreases from kd 55 million to kd 45 million (the gap is 10). The value of aggregate expenditure in column 3 which have to change at each level of GDP to eliminate the recessionary gap is kd 300 million – kd 250 million = kd 50 million

c)       Assuming that investment, net exports and government expenditures do not change with changes in real GDP.

  • ∆C = 5; ∆Y = 20

So, MPC = ∆C/∆Y

= 5/20

= 0.4

  • MPS = 1 – MPC

= 1 – 0.4

= 0.6

  • µ = 1/(1-MPC)

= 1/1-0.4

= 1/0.6

= 1. 67


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