Download ECON 102 Tutorial 3

ECON 102
Tutorial 3
TA: Iain Snoddy
18 May 2015
Vancouver School of Economics
Questions
Questions 1-3 set-up
Y
C
1.00 1.00
2.00 1.65
3.00 2.30
4.00 2.95
5.00 3.60
6.00 4.25
Note: All
I
G
X
0.5 0.7 0.45
0.5 0.7 0.45
0.5 0.7 0.45
0.5 0.7 0.45
0.5 0.7 0.45
0.5 0.7 0.45
figures in Trillion
M
0.15
0.30
0.45
0.60
0.75
0.90
$s
3/63
Question 1
Table 27.2.1 gives the aggregate expenditure schedule. Equilibrium
expenditure is equal to
(a) $4 Trillion
(b) $3 Trillion
(c) $5 Trillion
(d) zero
(e) $2 Trillion
4/63
Question 1: Calculating the Answer
From this table we know output/income (Y). We can also
calculate total expenditure by calculating
AE = C + I + G + (X − M ). This gives us:
Y
C
1.00
2.00
3.00
4.00
5.00
6.00
1.00
1.65
2.30
2.95
3.60
4.25
Note:
I
G
0.5 0.7
0.5 0.7
0.5 0.7
0.5 0.7
0.5 0.7
0.5 0.7
All figures
X
M
0.45 0.15
0.45 0.30
0.45 0.45
0.45 0.60
0.45 0.75
0.45 0.90
in Trillion $s
AE
2.50
3.00
3.50
4.00
4.50
5.00
5/63
Question 1: Calculating the Answer
Equilibrium occurs where output (Y) is equal to total desired
spending (AE). From the table this is where output is $4 trillion.
Side Note: Economists use many different definitions of
equilibrium. Typically they mean the point where no person has an
incentive to behave differently. Everyone is acting optimally.
6/63
Question 1: Answer
Table 27.2.1 gives the aggregate expenditure schedule. Equilibrium
expenditure is equal to
(a) $4 Trillion
(b) $3 Trillion
(c) $5 Trillion
(d) zero
(e) $2 Trillion
7/63
Question 2
Table 27.2.1 gives the aggregate expenditure schedule. Marginal
propensity to import is equal to
(a) 0.01
(b) 0.05
(c) 0.10
(d) 0.15
(e) 0.20
8/63
Question 2: Answer
The first thing to note here is that only two components change
with income: imports and private consumption. This means that
as output/income (Y) changes there is an ’induced’ change in C
and M. The other types of expenditure have no induced
component (ie they are autonomous). To calculate the MP to
Import we calculate ∆M
∆Y . Which is .15/1 = 0.15.
This means that as income increases, 15 cents of every additional
dollar of income is spent on foreign goods.
9/63
Question 2: Answer
Table 27.2.1 gives the aggregate expenditure schedule. Marginal
propensity to import is equal to
(a) 0.01
(b) 0.05
(c) 0.10
(d) 0.15
(e) 0.20
10/63
Question 3
Table 27.2.1 gives the aggregate expenditure schedule. If MPC =
0.8, net tax rate is equal
(a) 0.1575
(b) 0.1675
(c) 0.1775
(d) 0.1875
(e) 0.1975
11/63
Question 3: The Answer
So where does net tax rates enter into things? We know that
households consumer a fraction of their disposable income, and
that disposable income is equal to Income minus Taxes:
Y D = Y − T . T here is total tax paid. But normally taxes are a
function of income. Normally total income tax depends upon the
tax rate and the level of income you earn: T = tY .
This means that Y D = Y − tY . The consumption function is then
C = a + M P C × Y D = a + M P C × (1 − t)Y .
It is no longer true that
∆C
∆Y D
=
∆C
∆Y !
Be very careful of this!
12/63
Question 3: The Answer
Instead
∆C
∆Y
= M P C × (1 − t).
Using the table we can calculate
∆C
∆Y
= .65/1 = .65.
So:
∆C
∆Y
∆C
∆Y .
We also know the MPC=0.8.
= .65 = 0.8 × (1 − t)
(1 − t) =
.65
.8
= 0.8125
t = 1 − 0.8125 = 0.1875
13/63
Let’s calculate the entire AE function (just for fun)
So here is what we know: I = 0.5, G = 0.7, X = 0.45,
M P I = 0.15, t = 0.1875, M P C = 0.8
We also know that C = a + M P C × Y D and that
M = d + MPI × Y .
Or C = a + 0.8 × Y D and M = d + 0.15 × Y
We can show that d = 0, when income is zero, imports are zero.
Let’s find a: C = a + 0.8 × (1 − 0.1875) × Y = a + 0.65 × Y .
Plugging in some values gives: 1 = a + 0.65 × 1. So a = 0.35.
Using AE = C + I + G + X − M
gives:AE = 0.35 + 0.65 × Y + 0.5 + 0.7 + 0.45 − 0.15 × Y
AE = 2 + 0.5 × Y
14/63
Final Check
So we have the AE function
AE = 2 + 0.5 × Y
To check let’s plug in some Y values and see that they give the
correct value of AE.
When Y=1, AE=2.5. Check
When Y=2, AE=3. Check
When Y=6, AE=5. Check
15/63
Question 3: Answer
Table 27.2.1 gives the aggregate expenditure schedule. If MPC =
0.8, net tax rate is equal
(a) 0.1575
(b) 0.1675
(c) 0.1775
(d) 0.1875
(e) 0.1975
16/63
Question 4
If there is a decrease in autonomous expenditure, the new AE
curve is
(a) flatter than the original AE curve.
(b) steeper than the original AE curve.
(c) parallel and above the original AE curve
(d) parallel and below the original AE curve.
(e) none of the above.
17/63
Question 4: Answer
If there is a decrease in autonomous expenditure, the new AE
curve is
(a) flatter than the original AE curve.
(b) steeper than the original AE curve.
(c) parallel and above the original AE curve
(d) parallel and below the original AE curve.
(e) none of the above.
18/63
Explaining the Answer
The AE function/curve takes the general form: AE = a + z × Y .
The slope of the curve is given by z. The Y intercept is given by a.
If a changes and z does not then there is no change in the slope. A
change to a only brings about a shift of the curve.
19/63
A review of the multiplier
1
We know that the multiplier is 1−z
, and measures the change in
output resulting from a change in autonomous expenditure. This
change is often more than 1. (Remember last week we said the
demand side is really powerful in this model).
One quick check to see if the multiplier is large or small is to look
at the slope of the AE function. If z is large the multiplier is large!
20/63
A review of the multiplier
Why does a large z mean a large multiplier intuitively?
The reason expenditure drives a greater than 1 increase in output
is that expenditure becomes income for somebody else. This
person then spends some of their income. This spending becomes
income for somebody else and the process repeats.
If z is larger then each round when income increases people spend
more, generating a higher amount of income for others. The entire
process lasts longer.
21/63
A review of the multiplier
Let’s consider a numerical example.
AE = 100 + 0.5Y
If autonomous expenditure increases to 200 there is an initial
increase in spending of 200.
This autonomous change becomes income for someone else. This
then leads to further induced expenditure of $50 (0.5 × 100). This
$50 becomes income for someone else. This person then spends
$25 dollars. The process repeats over and over.
22/63
A review of the multiplier
This table shows the successive rounds of spending:
Round
Increase in Expenditure
Total
1
2
3
4
5
100
50
25
12.5
6.25
100
150
175
187.5
193.75
The rounds will keep going and eventually the total will reach
1
100 × 1−z
= 200
23/63
A review of the multiplier
Another way to see the multiplier is graphically. We can draw the
shift in the AE curve when spending increases.
400
300
AE 200
100
0
0
100
200
300
400
24/63
A review of the multiplier
400
300
AE
200
100
0
0
100
200
Y
300
400
25/63
A review of the multiplier
Let’s see what is moving us from one equilibrium to another
400
300
AE
200
100
0
0
100
200
Y
300
400
26/63
A review of the multiplier
After the spending increase income increases
400
300
AE
200
100
0
0
100
200
Y
300
400
27/63
A review of the multiplier
This generates a further increase in expenditure
400
300
AE
200
100
0
0
100
200
Y
300
400
28/63
A review of the multiplier
And then an increase in income
400
300
AE
200
100
0
0
100
200
Y
300
400
29/63
A review of the multiplier
And on and on
400
300
AE
200
100
0
0
100
200
Y
300
400
30/63
For the Mathy people
For those interested note that the multiplier formula just comes
from the geomatric sequence formula.
Every round of successive spending is just the multiplier times the
induce change in spending.
This means the first round is 100 × 0.50 . The second is
100 × 0.5 = 50. The third is 50 × 0.5 = 100 × 0.52 . The fourth is
25 × 0.5 = 100 × 0.53 .
This goes on to infinity.
The geometric sum of these rounds is:
100 + 100 × 0.51 + 100 × 0.52 + ....
This is just a geometric sequence the sum of which is
1
1−0.5
31/63
Question 5
All else constant, a decrease in the income tax rate will result in
(a) a movement down along the aggregate expenditure curve.
(b) an upward shift of the AE curve with no change in its slope
(c) a downward shift of the AE curve with no change in its slope.
(d) a decrease in the consumption expenditure. .
(e) an AE curve with a steeper slope.
32/63
Question 5: Answer
All else constant, a decrease in the income tax rate will result in
(a) a movement down along the aggregate expenditure curve.
(b) an upward shift of the AE curve with no change in its slope
(c) a downward shift of the AE curve with no change in its slope.
(d) a decrease in the consumption expenditure.
(e) an AE curve with a steeper slope.
33/63
The Answer
Remember that the slope of the AE curve is given by z, ie the
Marginal Propensity to Spend. We know that the MPS depends
upon the tax rate and so will change with taxes.
Specifically M P S = M P C × (1 − t) − M P I
So if t increases the MPS will fall. The curve will become flatter.
34/63
The Answer
Remember that this will cause a pivot of the curve around the
Y-intercept. Autonomous expenditure has not changed!
400
300
AE 200
100
0
0
100
200
Y
300
400
35/63
Question 6
Everything else remaining the same, which one of the following
would increase equilibrium real GDP?
(a) an increase in saving
(b) an increase in exports
(c) a decrease in investment
(d) an increase in taxes
(e) a decrease in exports
36/63
Question 6: Answer
Everything else remaining the same, which one of the following
would increase equilibrium real GDP?
(a) an increase in saving
(b) an increase in exports
(c) a decrease in investment
(d) an increase in taxes
(e) a decrease in exports
37/63
Question 6 Answer
All of the other answers will decrease expenditure, lowering real
GDP. In particular a decrease in investment and exports will
decrease autonomous spending. An increase in taxes will shift the
AE curve downwards and lower real GDP. If saving is coming from
an autonomous decrease in consumption the AE curve will shift
down. If it is due to a fall in the MPC, the curve will pivot
downwards.
38/63
Question 7
The slope of the AE curve equals
(a) aggregate expenditure divided by real GDP
(b) the change in aggregate expenditure divided by the change in
real GDP
(c) the change in consumption divided by the change in real GDP
(d) the change in consumption plus government expenditure
divided by the change in aggregate income
(e) the change in income divided by the change in autonomous
expenditure
39/63
Question 7: Answer
The slope of the AE curve equals
(a) aggregate expenditure divided by real GDP
(b) the change in aggregate expenditure divided by the
change in real GDP
(c) the change in consumption divided by the change in real GDP
(d) the change in consumption plus government expenditure
divided by the change in aggregate income
(e) the change in income divided by the change in autonomous
expenditure
40/63
Question 8
The short-run aggregate supply curve indicates
(a) the relationship between the price level and real GDP
demanded by consumers, investors, governments, and net
exporters
(b) the relationship between the price level and the natural
unemployment rate
(c) the relationship between the purchasing power of wages and
the quantity of labour supplied by households
(d) the relationship between the quantity of real GDP supplied and
the price level when the money wage rate, the prices of other
resources, and potential GDP remain constant
(e) the various quantities of real GDP producers supply at
different income levels
41/63
Question 8
The short-run aggregate supply curve indicates
(a) the relationship between the price level and real GDP
demanded by consumers, investors, governments, and net
exporters
(b) the relationship between the price level and the natural
unemployment rate
(c) the relationship between the purchasing power of wages and
the quantity of labour supplied by households
(d) the relationship between the quantity of real GDP
supplied and the price level when the money wage rate,
the prices of other resources, and potential GDP remain
constant
(e) the various quantities of real GDP producers supply at
different income levels
42/63
Question 9: Set-up
43/63
Question 9
Refer to Figure 26.1.1. Which graph illustrates what happens when
factor prices decrease?
(a) a
(b) b
(c) c
(d) d
(e) a and b
44/63
Question 9
Refer to Figure 26.1.1. Which graph illustrates what happens when
factor prices decrease?
(a) a
(b) b
(c) c
(d) d
(e) a and b
45/63
Question 9
Firms are now willing to supply more at every level of output as
the cost of producing goods is lower. In other words, they can
produce more goods at a lower price and still make a profit.
46/63
Question 10
Long-run aggregate supply will increase for all of the following
reasons except
(a) a fall in the money wage rate
(b) an increase in human capital
(c) the introduction of new technology
(d) an increase in the full-employment quantity of labour
(e) an increase in the quantity of capital
47/63
Question 10: Answer
Long-run aggregate supply will increase for all of the following
reasons except
(a) a fall in the money wage rate
(b) an increase in human capital
(c) the introduction of new technology
(d) an increase in the full-employment quantity of labour
(e) an increase in the quantity of capital
48/63
The Long-Run in Economics
The Long-run is a rather odd concept in Economics. We are never
actually in the long-run! What it means is that if you were to plot
data over a long time scale a particular pattern would emerge.
Think of GDP fluctuating around potential. If you plot GDP over a
few years it might not tell you all that much. But plotting a lot
more years can give a very clear pattern.
49/63
The Long-Run in Economics
In terms of Aggregate supply factor prices can fluctuate for many
reasons. But there will be a long-run pattern to how these prices
are changing based on technology and the supply and demand of
these factors.
In the Long-run the economy is at potential meaning that factor
prices have adjusted to remove the output gap. Potential output is
determined by technological progress, the labour market and
capital stocks. This shift the LRAS curve.
50/63
The Long-Run in Economics
This focus on the Long-run is the cornerstone of Neo-classical
economists. These economists believe that market forces lead to
the optimal equilibrium outcome eventually if left alone. Note that
supply is important here. In the long run supply is what matters.
This is in contrast to out short-run AE model where Demand was
key.
51/63
Question 11
The quantity of real GDP demanded is composed of the purchases
of
(a) households and net exporters only
(b) firms, bondholders, and net exporters only
(c) firms and governments only
(d) consumers, firms, governments, and net exporters
(e) consumers, firms, and governments only
52/63
Question 11: Answer
The quantity of real GDP demanded is composed of the purchases
of
(a) households and net exporters only
(b) firms, bondholders, and net exporters only
(c) firms and governments only
(d) consumers, firms, governments, and net exporters
(e) consumers, firms, and governments only
53/63
Question 11: Answer
Remember that the demand curve is derived form the AE model.
Each point on the demand curve represents the equilibrium level of
expenditure/purchases that would take place given the price level.
As the price falls people buy less, the AE curve shifts down and
output falls. This is the logic behind the downward sloping AD
curve.
54/63
Question 12
If the price level rises, then the wealth effect leads to
(a) an increase in real wealth, an increase in current consumption
expenditure, and an increase in saving
(b) an increase in real wealth, an increase in current consumption
expenditure, and a decrease in saving
(c) a decrease in real wealth, an increase in current consumption
expenditure, and an increase in saving
(d) a decrease in real wealth, an increase in current consumption
expenditure, and a decrease in saving
(e) a decrease in real wealth, a decrease in current consumption
expenditure, and an increase in saving
55/63
The Wealth Effect
The Wealth Effect
The wealth effect states that individuals will consume less if
they perceive a decrease in their wealth
56/63
Question 12
If the price level rises, then the wealth effect leads to
(a) an increase in real wealth, an increase in current consumption
expenditure, and an increase in saving
(b) an increase in real wealth, an increase in current consumption
expenditure, and a decrease in saving
(c) a decrease in real wealth, an increase in current consumption
expenditure, and an increase in saving
(d) a decrease in real wealth, an increase in current consumption
expenditure, and a decrease in saving
(e) a decrease in real wealth, a decrease in current
consumption expenditure, and an increase in saving
57/63
Question 13
When the economy of Econoworld
is in short-run Macroeconomic
equilibrium, the price level is
(a) 100
(b) 90
(c) 75
(d) 70
(e) 85
58/63
Question 13: Answer
When the economy of Econoworld
is in short-run Macroeconomic
equilibrium, the price level is
(a) 100
(b) 90
(c) 75
(d) 70
(e) 85
59/63
Question 14
If Econoworld automatically adjusts to a
long-run equilibrium, then in the
long-run macroeconomic equilibrium
(a) the price level is 70
(b) real GDP is $440 billion
(c) actual unemployment exceeds the
natural unemployment rate
(d) potential GDP is greater than in
the short run
(e) both A and B
60/63
Question 14: Answer
If Econoworld automatically adjusts to a
long-run equilibrium, then in the
long-run macroeconomic equilibrium
(a) the price level is 70
(b) real GDP is $440 billion
(c) actual unemployment exceeds the
natural unemployment rate
(d) potential GDP is greater than in
the short run
(e) both A and B
61/63
Question 14: Answer
Long-run adjustment takes place through factor-price adjustment.
This means that wages and rents adjust to return the economy to
long-run equilibrium. Here there is a recessionary gap. This means
there is an excess supply of factors of production. The price of
these factors will fall and so the supply curve will shift to the right.
62/63
That’s it
Good luck on the Midterm!
63/63