Download Macro1 Exercise #5 Answers

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Macro1 Exercise #5 Answers
Please limit your answers to the spaces provided. If necessary, write on the back of the page.
Do not attach printout or additional pages. All questions pertain to the Macro1 module in the
SimEcon® software package.
Make sure that you have read the “Macro1 Manual” and SimEcon® Operation Instructions”.
These materials may be found at the Class Web site prior to beginning the exercise. For many of
the exercise’s questions, it will be necessary to refer to those instructions. For many of the
exercise’s questions, it will be necessary to refer to your text.
Open the Macro1 module. You will see a table called “State of the Macroeconomy”. Select
“Recession” and click “Continue”. You will see a table entitled, “Initial Conditions: Recession”.
Fill in the amounts in the table below.
Real GDP:
Unemployment Rate:
$4,018.18
10.00%
Consumption: $2,589.68
Inflation Rate: 1.47%
Economists usually say that there is a recession when the unemployment rate rises above what
percent? Economists will say there is a recession when the unemployment rate goes above
5.00%. What is the inflation rate at this point? 1.47%. Would most economists consider this
to be an acceptable level of inflation? Yes (Yes, No). Would a level of inflation such as this be
considered unavoidable in a growing economy? Yes (Yes, No).
Is the government running a surplus, a deficit or neither? The government is running neither a
surplus nor a deficit. What are the three tools in this module that the government can use to
combat unemployment? The administration can change government spending, taxes or the
interest rate. Other things being equal, and assuming that the high unemployment rate was its
only concern, this administration would want to increase (increase, decrease, leave unchanged)
government spending, decrease (increase, decrease, leave unchanged) taxes and decrease
(increase, decrease, leave unchanged) the interest rate.
Click “Continue”. You will see a table entitled, “Macro Policy Tools”. Select the button
entitled, “Taxes” and click “Continue”. Increase taxes to $1300 and click “Continue”. Fill in the
amounts below for “Long Run Results”.
Real GDP:
Unemployment Rate:
$3,568.18
14.00%
Consumption: $2,139.68
Inflation Rate: 1.22%
What has happened to GDP as a result of this policy? It has gone down. What has happened to
the unemployment rate as a result of this policy? It has increased.
Course
Macro1 Exercise #5 Answers
Page 2
Compare these last results with the initial situation. Is this economy is experiencing economic
expansion, economic stagnation or economic decline? Economic decline.
Considering that the economy is in a recession, should the government have increased taxes? No
(Yes, No). Why or why not? The economy is in a recession, so the government should be
decreasing taxes to stimulate the economy. Decreasing taxes will cause GDP to increase
and the unemployment rate to decrease, other things being equal.
How much of a tax cut would it take to get GDP to the full employment GDP ($4500) from its
value in the initial conditions? The “gap” between GDP at full employment and the initial
value ($4018.18) was $481.82. Previously the tax increase of $50 caused GDP to go down
by $450. That means the tax multiplier (change in GDP/change in taxes) is 9. That means
that to get an increase in GDP of $549.81 would require a tax cut of ($481.82/9) = $53.54, a
tax level of $1197.47.
Click “Reset Policy” and then click the “Back” button. You will arrive back at the table entitled,
“Macro Policy Tools”. Select the button entitled, “Taxes” and click “Continue”. Cut taxes to
$1197.47 and click “Continue”. Fill in the amounts below for “Long Run Results”.
Real GDP:
Unemployment Rate:
$4,999.95
5.00%
Consumption: $3,071.45
Inflation Rate: 1.50%
What has happened to GDP as a result of this policy? It has gone up. What has happened to
the unemployment rate as a result of this policy? It has decreased. By comparing these last
results with the initial situation, would you say that this economy is experiencing economic
expansion, economic stagnation or economic decline? Economic expansion.
What is the formula for the marginal propensity to consume? The marginal propensity to
consume is calculated by dividing the change in consumption by the change in income. By
comparing these results with the results for the “Initial Conditions”, you can calculate the
marginal propensity to consume. Perform the calculations below and indicate your final answer.
New Consumption - Old Consumption = Change in Consumption:
$3,039.68 - $2,589.68 = $450.00
New Income (after Taxes) – Old Income (after taxes) = Change in Income
(New GDP – New Taxes) – (Old GDP –Old Taxes) =
($4499.95 – 1197.47) – ($4018.18 – 1250) =
$3302.27 – 2768.18 = $534.07
Change in Consumption divided by Change in Income (after Taxes)
Propensity to Consume
$450/$500 = 0.90 = MPC
=
Marginal
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Macro1 Exercise #5 Answers
Page 3
What is the formula for the tax multiplier? The tax multiplier is calculated as follows:
MPC/(1 – MPC). Using the results from this last question, you can calculate the multiplier. Do
this below, showing all your calculations:
1 – MPC = 1 – 0.90 = 0.10
MPC/(1 – MPC) = .90/.10 = 9
You should still be at the results table from cutting taxes to $1196.47. Click “See Graph” and
draw the resulting graph below. Indicate the old and new aggregate expenditure curves, the
aggregate supply curve, and the old and new equilibrium points and label all axes.
45• line
AE’
Planned
Spending
AE
GDPE
GDPE’
AE = Old Aggregate Expenditure
AE’ = New Aggregate Expenditure
GDPE = Old Equilibrium
GDPE’ = New Equilibrium
Real GDP
What happened to the aggregate expenditure curve? It shifted up. Now, click “AD-AS Graph”
and draw the resulting graph below:
Price
Level
AS
GDPFE* = Full Employment Output
AD
GDPFE
Real GDP
Is this economy at full employment, below full employment or above full employment? This
economy is at full employment. How can you answer this question using the above graph?
The economy represented by the above graph is at equilibrium where the AS and AD
curves intersect.
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Macro1 Exercise #5 Answers
Page 4
Now, click the “Back” button twice. You will arrive back at the table entitled, “Macro Policy
Tools”. Select the button entitled, “Interest Rate” and click “Continue”. In the real world, how
is the interest rate adjusted, through monetary or fiscal policy? It is accomplished through
monetary policy. What is monetary policy? Monetary policy describes actions of the
Federal Reserve Bank to regulate the money supply and interest rates. Decrease the interest
rate to 5.8% and click “Continue”. Fill in the amounts below for “Long Run Results”.
Real GDP:
Unemployment Rate:
$4,088.18
9.00%
Consumption: $2,656.13
Inflation Rate: 1.48%
Compared to the “Initial Conditions” table, what has happened to real GDP? Real GDP has
increased slightly. Likewise, what has happened to unemployment? Unemployment has
decreased slightly. Did this policy succeed to some extent in combating the recession? Yes
(Yes, No). Given these results, should the interest rate be decreased to a greater degree, to a
lesser degree or not changed at all? The interest rate should be decreased to a greater degree.
Click “Reset Policy” and enter a new interest rate of 5.2%. Click “Continue”. Fill in the
amounts below for “Long Run Results”.
Real GDP:
Unemployment Rate:
$4,298.18
7.00%
Consumption: $2,855.48
Inflation Rate: 1.50%
Compared to the last example, what has happened to real GDP? Real GDP has increased
slightly. Likewise, what has happened to unemployment? Unemployment has decreased
slightly. Did this policy succeed to some extent in combating the recession? Yes (Yes, No).
Given these results, should the interest rate be decreased to a greater degree, to a lesser degree or
not changed at all? The interest rate should be decreased to a greater degree. Click “Reset
Policy” and enter a new interest rate of 4.50%. Click “Continue”. Fill in the amounts below for
“Long Run Results”.
Real GDP:
Unemployment Rate:
$4,543.18
5.00%
Consumption: $3,088.06
Inflation Rate: 5.81%
Does a significant number of economist’s consider an unemployment rate of less than 5% to be
“acceptable”? Yes (Yes, No). How do economists justify an unemployment rate of 5%? Some
economists claim that a modern post-industrial economy requires such a high degree of
mobility of factors and production facilities that there is going to be so much transitional
unemployment that an unemployment rate of 5% is unavoidable.
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Macro1 Exercise #5 Answers
Page 5
Click “See Graph”. Then click “AD-AS Graph”. Draw the resulting graph below.
Price
Level
AS
GDPE = Equilibrium GDP
GDPFE = Full Employment Output
AD
GDPYE GDPE
Real GDP
Is this economy at full employment, below full employment or above full employment? This
economy is above full employment. How can you show this? The vertical full employment
line at Y* is to the left of the equilibrium point. The equilibrium point indicates current
production. Thus, current production is above full employment. What is the actual value of
full employment output that is indicated below the horizontal axis? $4,500.00