DEMAND SIDE EQUILIBRIUM, INFLATIONARY
VERSUS RECESSIONARY GAP, AND FISCAL
STIMULUS VERSUS TAX CUT
In the country of Utopia, the structure of the economy is described as the following:
Y = C + I + G + (X – M)
C = C0 + (mpc)(DI)
I = I0 + (mpi)(Yd)
M = M0 + (mpm)(DI)
DI = Y – T
T = (t)(Y)
Where Y is the level of real GDP in the economy, DI denotes the disposable income in the economy,
C represents the level of consumption in the economy, C0 is the autonomous consumption level,
mpc denotes the marginal propensity to consume, I is the level of investment in the economy, I0
characterizes the autonomous investment, mpi is the marginal propensity to invest, G characterizes
the level of government expenditure, X is the level of export from the country, M represents the
amount of import in the country, M0 is the level of autonomous import, mpm denotes the marginal
propensity to import, T is the amount of tax imposed in the country, and t represents the average tax
rate in the economy.
After extensive research, the economists in Utopia believe that the following values (all the dollar
values are in number of millions) can be assigned to the structure of the economy,
C0 = $500; mpc = 0.8; I0 = $200; mpi = 0.2; G = $400; X = $300; M0 = $100; mpm = 0.1; and t =
0.25. The Utopian economists further believe that the level of potential GDP in the country is $4,000. 1. What is the demand side equilibrium level of real GDP in the country? Please show your
calculations.
2.
Is the overall Utopian economy in equilibrium? Elaborate your answer.
3.
If the economy is not in equilibrium, what will happen eventually? Explain your answer.
4.
What is the value of the overall multiplier? Please show your calculations and explain the
value.
ScholarMatic: Explanation & Answer
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