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Suppose in a closed private economy households are spending 75 cents from each additional dollar that they receive as an income. Moreover, when they do not have any income, they are still spending $100 on their needs
(a) If there is no investment in the economy, what is the equilibrium level of output?
(b) Suppose autonomous investment of $60 is added. What are the two ways to calculate the new equilibrium level of output? Is the change in equilibrium level of output the same as the change in autonomous expenditures? How can you explain the result? Give the intuition. Redraw the graphs from point (a) and show the changes on both graphs.
(c) Suppose that output is (i) $600 and (ii) 700. In each case what is the amount of the planned expenditures and of the actual expenditures? of planned investment and of saving? What would happen to the level of output in each case? Explain why. Compare the amount of unintended inventory investment with the change in output. How can you explain the difference? Redraw the resulting graphs from point (c) and show both situations on your both graphs.
Now suppose that in the situation, described in point (c) firms begin to reinvest to reinvest part of their profits worth 5% of national income. Derive the new investment function. What would be the new value of the equilibrium output and compare it with its value from point (c). How can you explain the change? Redraw the resulting graphs from point (c) and show the changes on both graphs
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