GE-Economics: Continuous Assessment

Jhanvi John
220338

Q-1. Solve for the equilibrium level of output in this economy. (5)

1. To solve for the equilibrium level of output in this economy, we need to set the
aggregate demand equal to the aggregate supply. In this case, the aggregate demand
(AD) consists of consumption (C), investment (I), and government spending (G), while
the aggregate supply (AS) represents the level of output in the economy.
AD = C + I + G
AS = Y
Given the equations: C = 120 + 0.5(Y - T)
I = 40
G = 20
T = 40
Substituting the values, we have: AD = (120 + 0.5(Y - 40)) + 40 + 20 AS = Y
Equating AD and AS: (120 + 0.5(Y - 40)) + 40 + 20 = Y
Simplifying the equation: 180 + 0.5(Y - 40) + 60 = Y
240 + 0.5Y - 20 = Y
0.5Y - Y = -220
-0.5Y = -220
Y = -220 / -0.5 Y = 440
Therefore, the equilibrium level of output in this economy is 440.

Q-2. There is a permanent increase in government spending of 10 units (so, now G=30).
Solve for the new equilibrium Y. (5)

2. To solve for the new equilibrium level of output (Y) after a permanent increase in
government spending (G = 30), we follow a similar approach as in the previous
question.
Given the updated value: G = 30
Substituting the values, we have: AD = (120 + 0.5(Y - 40)) + 40 + 30
AS = Y
Equating AD and AS: (120 + 0.5(Y - 40)) + 40 + 30 = Y
Simplifying the equation: 190 + 0.5(Y - 40) = Y
0.5Y - 20 = Y
-0.5Y = 20
Y = 20 / -0.5
Y = -40
Therefore, the new equilibrium level of output (Y) after the permanent increase in
government spending is -40.

Q-3. Elaborate on the concept of multiplier. (5)

3. The concept of multiplier refers to the magnification effect of changes in

autonomous expenditures (such as investment or government spending) on the
overall output and income in an economy. The multiplier effect occurs due to the
interdependence of various components of aggregate demand and the subsequent
ripple effects throughout the economy.
When there is an increase in autonomous expenditure, it leads to an initial increase in
aggregate demand. This increase in demand stimulates production and leads to an increase
in output. As output increases, incomes rise, which in turn boosts consumer spending. The
increased consumer spending further stimulates production and leads to additional rounds
of income and spending increases.
The multiplier effect is based on the concept of marginal propensity to consume (MPC),
which represents the proportion of each additional unit of income that is consumed. The
higher the MPC, the greater the multiplier effect. The multiplier is calculated as the inverse
of the marginal propensity to save (MPS), which represents the proportion of each
additional unit of income that is saved rather than consumed.
For example, if the MPC is 0.8 (80%) and the MPS is 0.2 (20%), the multiplier would be 1 /
0.2 = 5. This means that an initial increase in autonomous expenditure of $100 would lead to
a total increase in output and income of $500 (5 times the initial increase).
The multiplier effect amplifies the impact of changes in autonomous expenditure, whether
it's an increase or a decrease, on the overall economic activity. However, it's important to
note that the multiplier effect may vary depending on other factors such as the presence of
leakages (savings, imports, taxes) and assumptions about the behavior of households and
businesses.

Q-4.Explain the concept of full employment budget surplus. (5)

4. The concept of full employment budget surplus refers to a situation where the
government's budget is in surplus when the economy is operating at full employment
or potential output. Full employment refers to a situation where the economy is
utilizing all available resources efficiently, and there is no cyclical unemployment.
In such a scenario, the government's budget surplus can be achieved through a combination
of higher tax revenues and lower government expenditures. Higher tax revenues result from
increased economic activity and higher incomes, which lead to higher tax collections. Lower
government expenditures can be achieved by reducing government spending or
implementing fiscal restraint.
The full employment budget surplus is considered desirable as it signifies that the
government's revenues exceed its expenditures when the economy is already operating at
its maximum productive capacity. It can be seen as a form of fiscal prudence, allowing the
government to save funds for future needs, reduce public debt, or allocate resources to
other areas such as infrastructure investment, social programs, or tax cuts.
It's important to note that achieving a full employment budget surplus can be challenging in
practice, as economic conditions, government policies, and other factors can impact the
revenue and expenditure components of the budget. Additionally, the concept of full
employment itself is a theoretical benchmark, and actual economies may experience
fluctuations in employment levels over time.