An economy is characterized by the following behavioral equations: C = 100 + .8 Y D I = 100 G = 200 T = .25 Y Solve for each of the following. Show your calculations. Equilibrium GDP ( Y ) Disposable income ( Y D ) Consumption spending ( C ) Private saving Public saving Suppose government spending increases by 10 (?G=10). By how much will GDP change? (?Y=?) Solution C = 100 + .8 Y D I = 100 G = 200 T = .25 Y At equilibrium: Y=C+I+G Y=100+0.8(Y-T)+100+200 Y=100+0.8(Y-.25Y)+300 Y=400+0.6Y 0.4Y=400 Y=1000 Yd=Y-T Yd=1000-0.25 x 1000 Yd=750 C=100+0.8Yd C=100+0.8x 750 C=700 In equilibrium I+G=S+T 100+200=S+250 S=50 Public savings: S=T-G S=250-200 S=50 Private saving= Y-T-C 1000-250-700 =50 If G increases by 10, then G=210. Y=410+0.4Y Y=1025 GDP will increase by 25. Hence a 10 increase in government spending will increase GDP by 25. Government expenditure Multiplier= 25/10=0.25 .