Documented Problem Solving: Calculating Equilibrium Output
and is replicated here as part of the SERC Pedagogic Service.
The Keynesian model of the economy was presented in class. The difference between equilibrium GDP and potential GDP was discussed. In this exercise, students are provided with data to calculate equilibrium GDP. In addition, students are asked to describe the process they used to calculate the equilibrium and analyze the state of the economy. In the second part of this assignment, students repeat the process using slightly different data.
- understand the Keynesian model of the macroeconomy;
- describe the difference between equilibrium and potential output;
- apply this model to the concepts of equilibrium output and potential output;
- calculate equilibrium using data provided;
- analyze the state of the economy.
Context for Use
Description and Teaching Materials
For this activity, a question similar to the one below is necessary. The numbers in the formula can be changed to create a new problem.
Mathematical Model of Equilibrium Output
Suppose the following information reflects the closed economy of Casolari Land. The Consumption Function is such that C=300+.75(DI), Investment is fixed at $450 and the Government has a balanced budget, where both purchases and taxes equal $1,000.
These equations describe the economy:
C= 300 + .75(DI) [Consumption is determined by disposable income.)
E=C+I+G+NX [Aggregate demand is the total of consumption, investment, government purchases, and net exports.]
E=Y* [In equilibrium, total spending matches total income or total output.]
Calculate the equilibrium level of GDP for this economy (Y*).
Mathematical Model of Equilbrium Output (Microsoft Word 29kB Apr13 10)
Teaching Notes and Tips
Students must recognize that equilibrium GDP is not necessarily the same as potential GDP. They tend to believe that any equilibrium, per se, is good. In addition, they struggle with translating their understanding of the concepts of disposable income and a closed economy into a mathematical equation. Lastly, some students encounter problems solving simultaneous equations. Faculty should emphasize these concepts in class; having students work together or think-pair-share tends to alleviate these issues.
Students should be able to use the formulas given to find the equilibrium level of GDP and explain the thought process they used to do so, including any reference to notes, graphs, and definitions.
References and Resources