In an economy, the consumption function is C = 500 + 0.75 Y. Calculate equilibrium level of income, when investment expenditure is ₹5,000.
Answer & explanation
Correct answer: option 2
The correct answer is option (2) : ₹22,000
The equilibrium level of income is found where aggregate expenditure (AE) equals income (Y). In a closed economy, AE is the sum of the consumption (C) and investment (I).
The consumption function is given as C= 500 + 0.75Y, and
Investment (I) = 5,000
The aggregate expenditure (A) will be
A= C + I = (500 + 0.75Y) + 5,000
At equilibrium, AE = Y so we set them equal to each other :
Y = (500+ 0.75Y) + 5,000
Now, solve for Y :
0.25 Y = 5,500
Y = $\frac{5500}{0.25}$
Therefore, the equilibrium level of income is ₹22,000