Equilibrium with Government Purchases

We will use the multiplier approach to get the equilibrium with government purchases of goods and services. We'll use the same numerical example as before -- assuming that the marginal propensity to consume is 0.7, autonomous consumption is 500, and investment is 1000; but we will add 500 of government purchases. For now, no taxes -- all government spending is deficit spending financed by borrowing.

The autonomous spending is I+G+ autonomous consumption, that is, 1000+500+500=2000. Remember, too, with MPC=.7, the multiplier is 3.33.

Using those facts we can compute the equilibrium income for this example. Equilibrium income is 3.33*2000=6666.67.

As usual, we can visualize that in a graphical version of the model. Let's take a look at that.

The Graphic View