Problem
1. Explain the multiplier intuitively. Why is it that an increase in planned investment of $100 raises equilibrium output by more than $100? Why is the effect on equilibrium output finite? How do we know that the multiplier is 1/MPS?
2. You are given the following data concerning Freedonia, a legendary country:
(1) Consumption function: C = 200 + 0.8Y
(2) Investment function: I = 100
(3) AE C + I
(4) AE = Y
a. What is the marginal propensity to consume in Freedonia, and what is the marginal propensity to save?
b. Graph equations (3) and (4) and solve for equilibrium income.
c. Suppose equation (2) is changed to (2´) I = 110. What is the new equilibrium level of income? By how much does the $10 increase in planned investment change equilibrium income? What is the value of the multiplier?
d. Calculate the saving function for Freedonia. Plot this saving function on a graph with equation (2). Explain why the equilibrium income in this graph must be the same as in part b.
The response should include a reference list. Double-space, using Times New Roman 12 pnt font, one-inch margins, and APA style of writing and citations.