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ECON101 Module 8 (Exam 3) Exam – Introduction to Statistics –
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introduction to aggregate expenditures - CORRECT ANSWER- The aggregate expenditures model proposes that total spending (aggregate expenditures) in an economy will, in equilibrium, be equal to total output. In this model, aggregate expenditures are classified into four different categories, which are identified by who is buying the output: consumption by households, investment by firms, government purchases, and net exports. If any of these types of spending increase, aggregate expenditures will also increase; firms will have to produce more output to meet the additional demand. Thus, an increase in aggregate expenditures will lead to an increase in real GDP. marginal propensities to consume and save - CORRECT ANSWER- PART B: In which country would an increase in income lead to the largest change in consumption? Solution: The country that would have the largest change in consumption is the country that has the largest MPC. PART C: In which country would an increase in income lead to the largest change in savings?
Solution: The country that would have the largest change in savings as a result of a change in income is the country with the largest MPS. Since MPC + MPS = 1, the country with the highest MPS must also have the lowest MPC. After you've paid your taxes, you can do two things with an additional dollar of disposable income: spend it or save it. The fraction of each additional dollar that you choose to spend is called the marginal propensity to consume (MPC). The fraction that you save is called the marginal propensity to save (MPS). Because you must either spend the dollar or save it, MPC + MPS = 1. To determine the value of the MPC for an economy, we can observe a given increase in income (∆Y), see how much of it is spent on consumption (∆C), and then calculate MPC = ∆C/∆Y. consumption and income - CORRECT ANSWER- Autonomous consumption is equal to consumption expenditure when income equals zero. That consumption is funded by drawing on savings or by borrowing. Notice that the marginal propensity to consume (MPC) can be found by taking the change in C and dividing by the change in Y (real GDP): thus, the slope of the consumption function is also the MPC. PART C: Draw the equilibrium line representing the combinations of consumption and real GDP that are equal to each other. Solution: A line through the origin with a slope of 1 (or 45 degrees, depending on whether you prefer to express lines in slopes or degrees) would show all the combinations of consumption and real GDP that are equal. Note that at any point on this line, the length of a line from the
As income increases, most people will consume a fraction of the additional income and will save the rest. If we graph the relationship between income and savings, we create a savings schedule that shows how much is saved at different levels of income. In a simple aggregate expenditures model, the only component of spending is consumption; at equilibrium in that model, consumption is equal to real GDP. Thus, savings equals zero since all income is consumed. Savings becomes positive for the economy as a whole once we add other sectors (investment, government spending, and net exports) to make the model better reflect the real world. investment demand curve - CORRECT ANSWER- Investment occurs when a firm purchases new capital goods to replace worn-out equipment or to expand production. When firms consider investment, they compare the expected rate of return on the investment (the marginal benefit of investment) to the opportunity cost of the investment (the marginal cost). The opportunity cost of the investment is directly related to the interest rate, since firms either borrow for investment or use funds that could be earning interest. At lower interest rates, firms find it more profitable to undertake more investment projects, and the quantity of investment demanded increases. At higher interest rates, the quantity of investment demanded decreases. Thus, the investment demand curve, which shows the quantity of investment versus the interest rate, is a downward-sloping curve. investment, government purchases, and net exports schedules - CORRECT ANSWER- When real GDP increases, consumers spend some of the extra income and save the rest. When it comes to the other three components of aggregate expenditures (investment, government purchases, and net exports), the aggregate expenditures model
assumes there is no such positive relationship between real GDP and spending. The aggregate expenditures model assumes that these three components of aggregate expenditures are determined independently of real GDP, so changes in real GDP do not affect them. However, these three types of spending are important because they will change as a result of government policies and shocks to the economy, which will affect aggregate expenditures and, as a result, income. aggregate expenditures model equilibriums - CORRECT ANSWER- When you know the relationship between income and the four categories of spending (consumption, gross investment, government purchases, and net exports), you can combine them to develop aggregate expenditures. Of the four categories of spending, only consumption depends on income, so the slope of the aggregate expenditures line is the same as the slope of the consumption schedule: the marginal propensity to consume (MPC). Equilibrium in the economy occurs when aggregate expenditures are equal to the amount of output produced, AE = Y. If any part of AE (G, I, or NX) increases, the AE curve will shift up, resulting in higher equilibrium real GDP in the economy. expenditures multiplier - CORRECT ANSWER- In the aggregate expenditures model, consumption depends positively on income: The more income you have, the more you will consume. As a result, there is a multiplier effect whenever spending rises: Output increases to match the increased desire to buy goods and services. That output becomes income for someone else, who will want to spend some of that income on increased consumption.
to consume. Finally, the adjustment process can take years to complete. indentifying inflationary and recessionary gaps - CORRECT ANSWER- In the aggregate expenditures model, equilibrium output is determined by spending, and the resulting level of output may be above or below the full-employment level of real GDP. When output is below the full- employment level, a recessionary gap exists. When output is above the full-employment level, an inflationary gap exists. The size of the gap is equal to the size of the change in expenditures necessary to bring the economy back to full employment. To calculate this amount, divide the change in output necessary to return output to full employment by the expenditures multiplier. Which of the following statements describes the main idea behind Keynes's aggregate expenditures model? - CORRECT ANSWER- the demand for labor and the level of production depend on the level of expenditure in an economy The American Recovery and Reinvestment Act (ARRA) of 2009, which is commonly known as the "stimulus," was aimed at: - CORRECT ANSWER- reducing unemployment by increasing total expenditures The anticipated increase in profit resulting from additional economic investment is known as the: - CORRECT ANSWER- expected rate of return a. Compute the current MPC for each country.
Country Change in Income Change in Consumption Adrup $9,500 $5, Bedrup 37,000 27, Cedrup 5,600 5, b. Which country has the highest marginal propensity to save (MPS)? c. If income in Bedrup increases by $300 and income in Cedrup increases by $600, which of the following statements is correct? - CORRECT ANSWER- a. Adrup 0. Bedrup 0. Cedrup 0. b. Adrup c. Bedrup will save more dollars a. Calculate the dollar amount of savings, the marginal propensity to consume (MPC), and the marginal propensity to save (MPS) for each level of income. After-Tax Income Consumption Spending $18,100 $ 9, 23,100 13, 29,975 19,
The graph below shows the consumption schedule for Zamunda. Research has yielded the following information about Zamunda: At the current interest rate, gross investment (I) is $500, government purchases (G) are $800, exports are $400, and imports are $200. a. By supplementing the consumption schedule in the graph below to include the expenditures for gross investment (I), government purchases (G), and net exports (NX) stated above, what is the new value of the vertical intercept? c. Calculate the slope of the consumption schedule before the inclusion of I + G + NX. Then calculate the slope of the entire aggregate expenditures schedule (C + I + G + NX). d. The slope of the aggregate expenditures schedule (C + I + G + NX) represents ____________ - CORRECT ANSWER- a. 23, c. Before the inclusion of I + G + NX: 0. Entire aggregate expenditures schedule: 0. d. the MPC Notice that the marginal propensity to consume (MPC) is found by taking the change in consumption and dividing by the change in real GDP. So the slope must be the MPC The table below shows the annual consumption expenditure (C) and output (Y) for a fictitious nation. We assume that there are no taxes in
this nation, so disposable income (DI) is the same as income (Y). Furthermore, we know that at the current real interest rate, gross investment (I) is $300, government purchases (G) are $300, and net exports (NX) are - $100. Note that the negative net exports value implies that imports are greater than exports for this nation. a. Using the table below, compute the value for aggregate expenditures (AE = C + I + G + NX) for each level of output. Real GDP (Y) Consumption (C) $0 $ 1,000 1, 2,000 2, 3,000 2, 4,000 3, 5,000 4, b. What is the equilibrium level of output? - CORRECT ANSWER- a. Aggregate Expenditures (AE) $ 1750 2500 3250 4000 4750
government purchases by $50 billion or by raising taxes by the same amount. If it decreases government purchases, real GDP will decrease by $ billion, suggesting an expenditures multiplier of 2.5. If the government instead raises taxes, real GDP will decrease by $ billion, suggesting a tax multiplier of - 1.5. c. Which of the following statements best explains the diff - CORRECT ANSWER- a. We already know that the expenditures multiplier is computed as 1/(1 - MPC) or 1/MPS. For this country, the expenditures multiplier = 1/(1 - 0.8) = 1/0.2 = 5. So a $50 billion increase in government purchases will result in a $250 billion increase in real GDP ($50 billion × 5). The tax multiplier is computed as - MPC/(1 - MPC) or - MPC/MPS. For this economy, the tax multiplier equals - 0.8/0.2 = - 4. Therefore, a $50 billion decrease in taxes will result in a $200 billion increase in real GDP (-$50 billion × - 4). b. Again, the expenditures multiplier is computed as 1/(1 - MPC) or 1/MPS. For this country, the expenditures multiplier = 1/(1 - 0.6) = 1/0. = 2.5. So a $50 billion decrease in government purchases will result in a $125 billion decrease in real GDP ($50 billion × 2.5). Since the tax multiplier is computed as - MPC/(1 - MPC) or - MPC/MPS, the tax multiplier for this economy equals - 0.6/0.4 = - 1.5. Therefore, a $ billion increase in taxes will result in a $75 billion decrease in real GDP ($50 billion × - 1 .5). c. The tax multiplier is smaller since some of the extra disposable income is saved with a tax cut.
In terms of magnitude, note that the tax multiplier is smaller in both a and b. This difference in the two multipliers comes from the different effects on output of the very first transaction—the $50 billion going to or going from the government in this question. If the government uses $50 billion for government purchases, $50 billion in newly produced goods and services is being produced in the economy in exchange for that money. However, if the government instead reduces taxes by $ billion, nothing new is initially created in the economy. That money is given by the government to the people, but no output is produced in the process. Output begins to increase once citizens use that money to buy some Your research into a nation has yielded the following information: Autonomous expenditure (A) = $3, Gross investment (I) = $2, Government purchases (G) = $2, Net exports (NX) = - $1, Taxes (T) = $2, MPC = 0. a. Substitute the values above into the equation: AE = A + [MPC × (Y - T)] + I + G + NX. Then state the abbreviated equation for aggregate expenditures (AE). b. Using the abbreviated equation you computed in part a, complete the table below.
AE = 3,000 - 1,500 + 2,000 + 2,500 - 1,000 + 0.75Y
AE = 5,000 + 0.75Y
b. Aggregate Expenditures (AE) $ 11000 17000 23000 Using the equation 5,000 + 0.75Y, we can solve for AE at each level of output: When Y = 0, then AE = 5,000 + 0.75(0) = 5, When Y = 8,000, then AE = 5,000 + 0.75(8,000) = 11, When Y = 16,000, then AE = 5,000 + 0.75(16,000) = 17, When Y = 24,000, then AE = 5,000 + 0.75(24,000) = 23, c. Ye: 20, At the equilibrium level of output:
Y = AE
Y = AE = A + [MPC × (Y - T)] + I + G + NX
Y = A + [MPC × (Y - T)] + I + G + NX
Y - MPC × Y = A + (MPC × T) + I + G + NX
Y (1 - MPC) = A + (MPC × T) + I + G + NX
Ye = [A + (MPC × T) + I + G + NX]/(1 - MPC) Ye = [3,000 - 1,500 + 2,000 + 2,500 - 1,000]/(1 - 0.75) Ye = 5,000/0.25 = 20, d. 4 Note that the MPC of 0.75 suggests an expenditures multiplier of 4, from 1/(1 - MPC) or 1/0.25. So an increase in G (or any of the values G, I, NX, and A) by 1 will increase real GDP by 4. e. Ye: 24,
new AE line shows an expenditure value of $9,000. This means that the extra $2,000 of additional income generates $1,000 of additional expenditure ($9,000 instead of $8,000 on the equilibrium line AE = Y). c. 0. So each $1 increase in income causes a $0.50 increase in expenditures. The marginal propensity to consume (MPC), which is computed as Change in Expenditures/Change in Income, is 0.5. Alternatively, we can compute the MPC by calculating the slope of the original AE line. As income changes from $0 to $14,000, aggregate expenditures change from $3,000 to $10,000. Thus, the slope is 7,000/14,000 = 0.5. d. before: 6000 after: 10000 multiplier effect: 2 According to the graph, the equilibrium level of output increased from $6,000 to $10,000 when net exports increased by $2,000. This suggests that the $2,000 increase in expenditures created a $4, increase in real GDP and that the multiplier effect must be 2. Alternatively, we can compute the expenditures multiplier as 1/(1 - MPC) = 1/(1 - 0.5) = 1/0.5, or 2. a. According to the graph, this economy is currently experiencing a recessionary gap of $250. b. In the graph, show the shift in the aggregate expenditures schedule that establishes the full-employment level of output at $5,000.
c. To restore the full-employment level of real output, aggregate expenditures must be increased by $250. - CORRECT ANSWER- a. According to the graph, there is currently a recessionary gap of $250. A recessionary gap is the difference between expenditure when real GDP is below the full-employment level and the level of expenditure at full-employment real GDP. At the full-employment real GDP of $5,000, the current level of aggregate expenditures is $4,750, which is $ short of equilibrium. Note that the size of the recessionary gap is not referring to the fact that the current equilibrium level of real GDP ($4,000) is $1,000 lower than the full-employment real GDP of $5,000. b. See the graph above. c. To restore the full-employment real GDP, expenditures must be increased by $250. If done correctly, $5,000 would become the equilibrium level of output. The table below shows the consumption schedule for a hypothetical economy. All figures are in billions of dollars. Real GDP Consumption $600 $ 610 598 620 606 630 614 640 622
