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EXPENDITURE
MULTIPLIERS**
Answers to the Review Quizzes
Page 269
1.
(page 675 in Economics)
Which components of aggregate expenditure are influenced by real
GDP?
Consumption expenditure and imports are influenced by real GDP. Both
increase when real GDP increases.
2.
Define and explain how we calculate the marginal propensity to
consume and the marginal propensity to save.
The marginal propensity to consume is the proportion of an increase
in disposable income that is consumed. In terms of a formula, the
marginal propensity to consume, or MPC, can be calculated as ΔC/ΔYD,
where Δ means “change in.” The marginal propensity to save is the
proportion of an increase in disposable income that is saved. In
terms of a formula, the marginal propensity to save, or MPS, can be
calculated as ΔS/ΔYD.
3.
How do we calculate the effects of real GDP on consumption
expenditure and imports by using the marginal propensity to
consume and the marginal propensity to import?
The effects of real GDP on consumption expenditure and imports are
determined respectively by the marginal propensity to consume and
the marginal propensity to import. In particular, the effect of a
change in real GDP on consumption expenditure equals the marginal
propensity to consume multiplied by the change in disposable income.
Similarly, the effect of a change in real GDP on imports equals the
marginal propensity to import multiplied by the change in real GDP.
Page 273
1.
(page 679 in Economics)
What is the relationship between aggregate planned expenditure
and real GDP at equilibrium expenditure?
Equilibrium expenditure occurs when aggregate planned expenditure
equals real GDP.
2.
How does equilibrium expenditure come about? What adjusts to
achieve equilibrium?
Equilibrium expenditure results from adjustments in real GDP. For
instance, if aggregate planned expenditure exceeds real GDP, firms
find that their inventories are below their targets. In response,
firms increase production to meet their inventory targets,. And, as
production increases, real GDP increases. The increase in real GDP
increases aggregate planned expenditure. Eventually real GDP
*
* This is Chapter 11 in Macroeconomics.
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increases sufficiently so that it equals aggregate planned
expenditure and, at that point, equilibrium expenditure occurs.
3.
If real GDP and aggregate expenditure are less than equilibrium
expenditure, what happens to firms’ inventories? How do firms
change their production? And what happens to real GDP?
If real GDP and aggregate expenditure are less than their
equilibrium levels, an unplanned decrease in inventories occurs. The
unplanned decrease in inventories leads firms to increase production
to restore inventories to their planned levels. The increase in
production increases real GDP.
4.
If real GDP and aggregate expenditure are greater than
equilibrium expenditure, what happens to firms’ inventories? How
do firms change their production? And what happens to real GDP?
If real GDP and aggregate expenditure are greater than their
equilibrium levels, an unplanned increase in inventories occurs. The
unplanned increase in inventories leads firms to decrease production
to restore inventories to their planned levels. The decrease in
production decreases real GDP.
Page 278
1.
(page 684 in Economics)
What is the multiplier? What does it determine? Why does it
matter?
The multiplier is the amount by which a change in autonomous
expenditure is multiplied to determine the change in equilibrium
expenditure and real GDP. A change in autonomous expenditure changes
real GDP by an amount determined by the multiplier. The multiplier
matters because it tells us how much a change in autonomous
expenditure changes equilibrium expenditure and real GDP.
2.
How do the marginal propensity to consume, the marginal
propensity to import, and the income tax rate influence the
multiplier?
The marginal propensity to consume, the marginal propensity to
import, and the income tax rate all influence the magnitude of the
multiplier. The multiplier is smaller when the marginal propensity
to consume is smaller, when the marginal propensity to import is
larger, and when the income tax rate is larger.
3.
How do fluctuations in autonomous expenditure influence real GDP?
Fluctuations in autonomous expenditure bring business cycle turning
points. When autonomous expenditure changes, the economy moves from
one phase of the business cycle to the next. For example, if
autonomous expenditure decreases, equilibrium expenditure and real
GDP decrease and, as a result, the economy enters the recession
phase of the business cycle.
Page 283
1.
(page 689 in Economics)
How does a change in the price level influence the AE curve and
the AD curve?
A change in the price level shifts the AE curve and creates a
movement along the AD curve.
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EXPENDITURE MULTIPLIERS
2.
173
If autonomous expenditure increases with no change in the price
level, what happens to the AE curve and the AD curve? Which curve
shifts by an amount that is determined by the multiplier and why?
A change in autonomous expenditure with no change in the price level
shifts both the AE curve and the AD curve. The AE curve shifts by an
amount equal to the change in autonomous expenditure. The multiplier
determines the magnitude of the shift in the AD curve. The AD curve
shifts by an amount equal to the change in autonomous expenditure
multiplied by the multiplier.
3.
How does an increase in autonomous expenditure change real GDP in
the short run? Does real GDP change by the same amount as the
change in aggregate demand? Why or why not?
In the short run, an increase in aggregate expenditure increases
real GDP. However, the increase in real GDP is less than the
increase in aggregate demand because the price level rises. The more
the price level rises (the steeper the SAS curve) the smaller the
increase in real GDP.
4.
How does real GDP change in the long run when autonomous
expenditure increases? Does real GDP change by the same amount as
the change in aggregate demand? Why or why not?
In the long run, an increase in aggregate expenditure has no effect
on real GDP, that is, real GDP does not change. The change in real
GDP—zero—is less than the change in aggregate demand. The change in
real GDP is nil because, in the long run, the economy returns to its
full-employment equilibrium. In the long run, an increase in
aggregate expenditure raises the price level but has no effect on
real GDP.
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CHAPTER 11
Answers to the Study Plan Problems and Applications
Use the following
You are given the
about the economy
1. Calculate the
consume.
data to work Problems 1 and 2.
information in the table
Disposable Consumption
of the United Kingdom.
income
expenditure
marginal propensity to
(billions of pounds
per year)
300
340
The marginal propensity to consume is
400
420
the fraction of a change in disposable
500
500
income that is consumed. In the United
600
580
Kingdom, when disposable income
700
660
increases by £100 billion per year,
consumption expenditure increases by £80 billion per year. The
marginal propensity to consume equals £80 billion ÷ £100 billion,
or 0.8.
2.
Calculate saving at each level of disposable income and calculate
the marginal propensity to save.
Disposable
The table to the right shows the United
income
Saving
Kingdom’s saving schedule. Saving equals
(billions of pounds
disposable income minus consumption
per year)
expenditure.
300
−40
The marginal propensity to save is the
400
−20
fraction of a change in disposable
500
0
income that is saved. In the United
600
20
Kingdom, for each increase in disposable
700
40
income of £100 billion, saving increases
by £20 billion, so the marginal propensity to save is £20 billion ÷
£100 billion, which is 0.2.
3.
Collapsing Savings Rate
Before 1984, the U.S. savings rate held steady for decades,
though it dipped during the Great Depression and rose sharply
during WWII, when there was little to buy besides war bonds. The
rate dipped briefly again after WWII, and then rose steadily
until 1984, when saving was 10.2 percent of income. Since 1984,
saving has fallen to between 2 percent and 3 percent of income.
Source: Deseret, August 18, 2012
Compare the MPC and MPS in the United States at different dates.
Why might they differ?
The MPC is (much) higher and the MPS is (much) lower in recent years
than in 1984. The MPC might be higher in recent years because the
return to saving (and the cost of borrowing) is lower than in 1984.
Additionally wealth and perhaps expected future income might be
higher in recent years than in 1984, in which case consumption is
higher and saving lower in recent years.
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Use Figure 11.1 to work Problems 4
and 5.
Figure 11.1 illustrates the
components of aggregate planned
expenditure on Turtle Island. Turtle
Island has no imports or exports, no
incomes taxes, and the price level is
fixed.
4. Calculate autonomous expenditure
and the marginal propensity to
consume.
Autonomous expenditure is $2
billion. Autonomous expenditure
is expenditure that does not
depend on real GDP. Autonomous
expenditure equals the value of
aggregate planned expenditure
when real GDP is zero.
The marginal propensity to
consume is 0.6. When the country
has no imports or exports and no income taxes, the slope of the AE
curve equals the marginal propensity to consume. When income
increases from zero to $6 billion, aggregate planned expenditure
increases from $2 billion to $5.6 billion. That is, when real GDP
increases by $6 billion, aggregate planned expenditure increases by
$3.6 billion. The marginal propensity to consume is $3.6 billion ÷ $6
billion, which is 0.6.
5. a. What is aggregate planned expenditure when real GDP is $6
billion?
Figure 11.1 shows that aggregate planned expenditure is $5.6 billion
when real GDP is $6 billion.
b. If real GDP is $4 billion, what is happening to inventories?
Firms’ inventories are decreasing. When real GDP is $4 billion,
aggregate planned expenditure exceeds real GDP, so firms sell all
that they produce and more. As a result, inventories decrease.
c. If real GDP is $6 billion, what is happening to inventories?
Firms are accumulating inventories. That is, unplanned inventory
investment is positive. When real GDP is $6 billion, aggregate
planned expenditure is less than real GDP. Firms cannot sell all
that they produce and inventories pile up.
6.
Explain the difference between induced consumption expenditure
and autonomous consumption expenditure. Why isn’t all consumption
expenditure induced expenditure?
Induced consumption expenditure is consumption expenditure that
changes when disposable income changes. Autonomous consumption
expenditure is consumption expenditure that would occur in the short
run even if disposable income was zero. Not all consumption
expenditure is induced consumption expenditure because, in the short
run, even if someone has no income they still will have some
(autonomous) consumption expenditure, if for nothing else, for food.
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7.
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Recovery?
In the second quarter, businesses increased spending on equipment
and software by 21.9%, while a category that includes home
building grew amid a rush by consumers to take advantage of tax
credits for homes.
Source: The Wall Street Journal, July 31, 2010
Explain how an increase in business investment at a constant
price level changes equilibrium expenditure.
Investment is a component of autonomous aggregate expenditure. An
increase in investment increases aggregate expenditure so the AE
curve shifts upward. Equilibrium expenditure increases.
Use the following data to work Problems 8 and 9.
An economy has a fixed price level, no imports, and no income taxes.
MPC is 0.80, and real GDP is $150 billion. Businesses increase
investment by $5 billion.
8. Calculate the multiplier and the change in real GDP.
With no imports and no income taxes, the multiplier equals 1/(1 −
MPC). So the multiplier is 1/(1 − 0.8), which is 5.0 Then the $5
billion increase in investment increases real GDP by 5.0 × $5
billion, which is $25 billion.
9.
Calculate the new real GDP and explain why real GDP increases by
more than $5 billion.
Real GDP was initially $150 billion. The increase in investment
increased real GDP by $25 billion, so real GDP increases to $175
billion. Real GDP increases by more than the initial increase in
investment because the increase in investment increases disposable
income which induces additional increases in consumption expenditure.
So real GDP increases both because investment increases and also
because of induced increases in consumption expenditure.
Use the following data to work Problems 10 and 11.
An economy has a fixed price level, no imports, and no income taxes.
An increase in autonomous expenditure of $2 trillion increases
equilibrium expenditure by $8 trillion.
10. Calculate the multiplier and the marginal propensity to consume.
The multiplier is defined as the change in equilibrium expenditure
divided by the change in autonomous expenditure. In this problem the
multiplier equals $8 trillion ÷ $2 trillion which is 4.0.
If there are no imports and no taxes, the multiplier can be
calculated from the formula that the multiplier equals 1/(1 − MPC).
The multiplier equals 4.0, so 4.0 = 1/(1 − MPC). Solving this
formula for the MPC shows that the MPC equals 0.75.
11. What happens to the multiplier if an income tax is introduced?
If an income tax is introduced, the multiplier decreases in value.
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Use the following data to work Problems 12 to 16.
Suppose that the economy is at full employment, the price level is
100, and the multiplier is 2. Investment increases by $100 billion.
12. What is the change in equilibrium expenditure if the price level
remains at 100?
The initial change in equilibrium expenditure is $200. The initial
effect of the increase in investment increases equilibrium
expenditure by the change in investment times the multiplier. The
multiplier is 2 and the change in investment is $100 billion, so the
initial change in equilibrium expenditure is $200 billion.
13.
a. What is the immediate change in the quantity of real GDP
demanded?
The quantity of real GDP demanded increases by $200 billion. The
increase in investment shifts the aggregate demand curve rightward by
the change in investment times the multiplier. The multiplier is 2
and the change in investment is $100 billion, so the aggregate
demand curve shifts rightward by $200 billion.
b.In the short run, does real GDP increase by more than, less than,
or the same amount as the immediate change in the quantity of
real GDP demanded?
In the short-run, real GDP increases by less than $200 billion. Real
GDP is determined at the intersection of the AD curve and the SAS
curve. In the short run, the price level will rise and real GDP will
increase but by an amount less than the shift of the AD curve.
14. In the short run, does the price level remain at 100? Explain why
or why not.
In the short run, the price level rises. Real GDP is determined at
the intersection of the AD curve and the SAS curve. In the short run,
the increase in aggregate demand means that the price level will
rise as the economy moves along its upward-sloping SAS curve.
15.
a. In the long run, does real GDP increase by more than, less
than, or the same amount as the immediate increase in the
quantity of real GDP demanded?
In the long run, real GDP equals potential GDP, so real GDP does not
increase. Real GDP is determined at the intersection of the AD curve
and the SAS curve. After the initial increase in investment, money
wages increase, the SAS curve shifts leftward, and in the long run,
real GDP moves back to potential GDP.
b. Explain how the price level changes in the long run.
Real GDP is determined at the intersection of the AD curve and the
SAS curve. In the long run, money wages increase so the SAS curve
shifts leftward, raising the price level by more than it rose in the
short run.
16. Are the values of the multipliers in the short run and the long
run larger or smaller than 2?
The multiplier in the short run is less than the multiplier of 2
because the short-run increase in real GDP is less than $200 billion.
The long-run multiplier is even smaller. It equals zero.
Use the following news clip to work Problems 17 and 18.
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CHAPTER 11
The New New Deal
Remember what was actually in the stimulus bill of 2009: slightly
more than $600 billion went toward poor and middle-class tax cuts,
safety net spending (more unemployment assistance and food stamps),
and aid to state governments with budget shortfalls. These are the
most directly simulative parts of the bill, bolstering demand and
preventing lay-offs—and stimulate they did. Economists of differing
ideological stripes generally agree that the economy would have as
many as 3 million fewer jobs now were it not for the stimulus. The
remaining sixth of the bill focused on longer-term investments, which
included putting $90 billion into green energy.
Source: Financial Times, September 2, 2012
17. Did the $600 billion of spending described above increase
aggregate expenditure by more than, less than, or exactly $600
billion? Explain.
The $600 billion of spending increases aggregate expenditure by more
than $600 billion because the spending from the $600 billion
stimulus increased disposable income and thereby has a multiplied
effect on the aggregate expenditure. Part of the $600 billion
increase is spent, leading the recipients’ incomes to increase. In
turn, part of this increase in income is spent, thereby further
increasing aggregate expenditure.
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18. Explain and draw a graph to illustrate how this fiscal stimulus
will influence aggregate expenditure and aggregate demand in both
the short run and the long run.
Figure 11.2 shows the short-run and long-run effects on aggregate
expenditure (Figure 11.2a) and on aggregate demand (Figure 11.2b).
In the short run the stimulus increases aggregate expenditure and
aggregate demand. The aggregate expenditure curve shifts upward from
AE0 to AE1 and the aggregate demand curve shifts rightward from AD0
to AD1. (The initial upward shift in the aggregate expenditure curve
is larger but the increase in the price level moderated the initial
increase in aggregate expenditure.) In the long run, however, shortrun aggregate supply decreases and the short-run aggregate supply
curve shifts from SAS0 to SAS1. While the higher price level does not
shift the aggregate demand curve, it does shift the aggregate
expenditure downward from AE1 back to AE0.
Use the following news clip to work Problems 19 to 21.
Consumer Growth Could Buoy China’s Economy
Annual double-digit wage growth since 2000 has created a Chinese
middle class ready to spend. And spend they have. Spending by China’s
consumers has grown at double-digit rates for a decade. Digital
Luxury Group, a Geneva-based market researcher, reports that Chinese
travelers made 70 million overseas trips in 2011 to places that
include Bali, Dubai, Paris, London, Singapore, and Hong Kong. To cope
with all this extra travel, China plans to build 56 new airports
before the end of 2016. China’s wealthy consumers in aggregate are
poised to spend more on luxury goods than consumers in Japan and the
United States.
Source: The New York Times, August 13, 2012
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19. Explain and draw a graph to illustrate the changes in autonomous
expenditure and induced expenditure and the multiplier process at
work in the above story.
There are two different effects on autonomous expenditure. The first
effect results from the increase in overseas trips. This effect
increases imports and thereby decreases autonomous expenditure. The
second
effect results from the
construction of additional
airports and expenditure on
luxury goods. Presuming that the
luxury goods are produced in
China, both of these changes
increase autonomous expenditure.
If the second effect is larger
than the first, on net
autonomous expenditure increases
and therefore induced
expenditures increase. As
illustrated in Figure 11.3, the
aggregate expenditure curve
shifts upward from AE0 to AE1.
20. Explain how China’s real GDP is influenced by an increase in
overseas travel and vacations.
Overseas travel and vacations increase China’s imports and thereby
decrease autonomous spending in China. The increase in imports
decreases aggregate expenditure and aggregate demand. These
decreases reduce China’s real GDP.
21. Explain how China’s consumption expenditure influences real GDP
in the countries to which Chinese tourists travel in the short
run and the long run.
The increase in China’s expenditure on trips abroad increases
aggregate expenditure and aggregate demand in these countries. In
the short run, real GDP and the price level both increase. In the
long run the price level in these countries rises, which decreases
aggregate expenditure and aggregate demand. In the long run, real
GDP does not change but the price level rises.
22. In the Canadian economy, autonomous consumption expenditure is
$50 billion, investment is $200 billion, and government
expenditure is $250 billion. The marginal propensity to consume
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181
is 0.7 and net taxes are $250 billion. Exports are $500 billion
and imports are $450 billion. Assume that net taxes and imports
are autonomous and the price level is fixed.
a. What is the consumption function?
The consumption function is the relationship between consumption
expenditure and disposable income, other things remaining the same.
In this case the consumption function is C = 50 + 0.7(Y – 250) where
the “50” is $50 billion and the “250” is $250 billion.
b. What is the equation of the AE curve?
The equation of the AE curve is AE = 375 + 0.7Y, where Y is real GDP
and the 375 is $375 billion. Aggregate planned expenditure is the
sum of consumption expenditure, investment, government purchases,
and net exports. Using the symbol AE for aggregate planned
expenditure, aggregate planned expenditure is
AE = 50 + 0.7(Y – 250) + 200 +250+ 50
AE = 50 + 0.7Y – 175 + 200 + 250 + 50
AE = 375 + 0.7Y
c. Calculate equilibrium expenditure.
Equilibrium expenditure is $1,250 billion. Equilibrium expenditure
is the level of aggregate expenditure that occurs when aggregate
planned expenditure equals real GDP. That is, AE = 375 + 0.7Y and AE
= Y. Solving these two equations for Y gives equilibrium expenditure
of $1,250 billion.
d. Calculate the multiplier.
The multiplier equals 1/(1 − the slope of the AE curve). The
equation of the AE curve tells us that the slope of the AE curve is
0.7. So the multiplier is 1/(1 − 0.7), which is 3.333.
e. If investment decreases to $150 billion, what is the change in
equilibrium expenditure?
Equilibrium real expenditure decreases by $166.67 billion. From part
d the multiplier is 3.333. The change in equilibrium expenditure
equals the change in investment, $50 billion, multiplied by 3.333.
f. Describe the process in part (e) that moves the economy to its
new equilibrium expenditure.
When investment decreases by $50 billion, aggregate planned
expenditure is less than real GDP. Firms find that their inventories
are accumulating above target levels. As a result, they decrease
production to reduce inventories. Real GDP decreases. The decrease
in real GDP decreases disposable income so that consumption
expenditure falls. In turn, the decrease in consumption expenditure
leads to a further decrease in aggregate planned expenditure. Real
GDP still exceeds aggregate planned expenditure though by less than
was initially the case. Nonetheless unwanted inventories are still
accumulating and firms continue to cut production, further reducing
real GDP. This process continues until eventually real GDP will
decrease enough to equal aggregate planned expenditure.
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Answers to Additional Problems and Applications
Use the following
and 24.
You are given the
about the economy
23. Calculate the
save.
data to work Problems 23
information in the table
of Australia.
marginal propensity to
Disposable
income
Saving
(billions of dollars
per year)
0
−5
100
20
200
45
300
70
400
95
The marginal propensity to save is the
fraction of a change in disposable
income that is saved. In Australia, when
disposable income increases by $100
billion per year, saving increases by $25 billion per year. The
marginal propensity to save is $25 billion ÷ $100 billion, which is
0.25.
24. Calculate consumption at each level of disposable income.
Calculate the marginal propensity to consume.
The table to the right shows
Disposable Consumption
Australia’s consumption expenditure
income
expenditure
schedule. Consumption expenditure
(billions
of
dollars
equals disposable income minus saving.
per year)
For each increase in disposable income
0
5
of $100 billion, consumption
100
80
expenditure increases by $75 billion.
200
155
The marginal propensity to consume is
300
230
0.75. The marginal propensity to
400
305
consume plus the marginal propensity to
save equals 1. Because the marginal propensity to save equals 0.25,
the marginal propensity to consume equals 0.75.
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Use the following news clip to work Problems 25 to 27.
Americans $2.4 trillion Poorer
The Federal Reserve reported that household wealth decreased by $2.4
trillion or $21,000 per household in the third quarter of 2011. This
drop is the steepest since 2008 and the second consecutive quarterly
drop. Foreclosures lowered household debt slightly but credit card
debt increased. Many households are struggling to buy the essentials
and spending on food has decreased. Separately, the Bureau of
Economic Analysis reported that consumption expenditure increased by
$39 billion in the third quarter of 2011.
Sources: The New American, December 11, 2011 and the Bureau of
Economic Analysis
25. Explain and draw a graph to illustrate how a fall in household
wealth would be expected to influence the consumption function
and saving function.
Figure 11.4a shows the effect of a decrease in wealth on the
consumption function and Figure 11.4b shows the effect on the saving
function. Consumption expenditure decreases so the consumption
function shifts downward from CF0 to CF1 while saving increases so
the saving function shifts upward from SF0 to SF1.
26. What factors might explain the actual changes in consumption
expenditure and wealth that occurred in the third quarter of 2011?
According to the article, consumption increased. At least two other
factors could explain the discrepancy between the “predicted”
decrease in consumption in part a and the increase that actually
occurred. First, disposable income might have increased. This change
would lead to a movement upward along the (downward-shifted)
consumption function so that consumption expenditure increased.
Alternatively people’s expected future incomes might have risen. The
upward revision in expected future income would lead to an upward
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shift of the consumption function which would offset the fall from
the decrease in wealth.
27. Draw a graph of a consumption function and show at what points
consumers were actually operating in the second and third
quarters. Make any necessary assumptions and explain your answer.
Regardless of any increase in future expected income, it is likely
the case that the decrease in wealth led to a net downward shift of
the consumption function because the decrease in wealth was so large.
In Figure 11.4a the consumption function shifts downward from CF0 to
CF1. Equally likely, however, disposable income increased. So the
economy moves from disposable income of $10.5 trillion and consuming
at point A on consumption function CF0 to disposable income of $11.0
trillion and consuming at point B on consumption function CF1.
A
1
2
3
4
5
6
7
A
B
C
D
E
F
B
Y
100
200
300
400
500
600
C
C
110
170
230
290
350
410
D
I
50
50
50
50
50
50
E
G
60
60
60
60
60
60
F
X
60
60
60
60
60
60
G
M
15
30
45
60
75
90
Use the spreadsheet above, which lists real GDP (Y ) and the
components of aggregate planned expenditure in billions of dollars,
to work Problems 28 and 29.
28. Calculate autonomous expenditure. Calculate the marginal
propensity to consume.
Autonomous expenditure equals the value of aggregate planned
expenditure when real GDP is zero. Because the spreadsheet does not
list GDP of zero, we must extrapolate to calculate the value of
consumption expenditure and imports when GDP equals zero. From the
spreadsheet, consumption expenditure falls by $60 billion for every
$100 billion decrease in GDP. So when GDP equals zero, autonomous
consumption expenditure is $50 billion. Similarly, from the
spreadsheet, imports decrease by $15 billion for every $100 billion
decrease in GDP. So when GDP equals zero, imports equal zero.
Autonomous expenditure is $50 billion (consumption expenditure) plus
$50 billion (investment) plus $60 billion (government expenditure)
plus $60 billion (exports), which equals $220 billion.
The marginal propensity to consume is 0.6. When income increases
from $100 billion to $200 billion, consumption expenditure increases
from $110 billion to $170 billion. A $100 billion increase in GDP
increases consumption expenditure by $60 billion. So the marginal
propensity to consume is $60 billion ÷ $100 billion, which is 0.6.
29.
a. What is aggregate planned expenditure when real GDP is $200
billion?
Aggregate planned expenditure is $310 billion. Aggregate planned
expenditure is the sum of consumption expenditure ($170 billion)
plus planned investment ($50 billion) plus government expenditure
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185
($60 billion) plus exports ($60 billion) minus imports ($30 billion),
which is $310 billion.
b. If real GDP is $200 billion, explain the process that moves the
economy toward equilibrium expenditure.
Inventories are decreasing so that the unplanned inventory change is
negative. When real GDP is $200 billion, aggregate planned
expenditure is $310 billion. Because aggregate planned expenditure
exceeds real GDP, firms sell all that they produce and even more so
that inventories are decreasing. Firms then increase their
production, to restore their inventories, and real GDP increases.
c. If real GDP is $500 billion, explain the process that moves the
economy toward equilibrium expenditure.
Firms are accumulating inventories so that the unplanned inventory
change is positive. When real GDP is $500 billion, aggregate planned
expenditure is $445 billion. Firms cannot sell all that they produce
so that unplanned inventories increase. Firms respond by decreasing
their production, to lower their inventories, and real GDP decreases.
30. Wholesale Inventories Decline, Sales Rise
The Commerce Department reported that wholesale inventories fell
1.3 percent in August for a record 12th consecutive month,
evidence that companies are trimming orders to factories, which
helped depress economic output during the recession. Economists
hope that the rising sales will encourage businesses to begin
restocking their inventories, which would boost factory
production and help bolster broad economic growth in coming
months.
Source: The New York Times, October 8, 2009
Explain why a fall in inventories is associated with recession
and a restocking of inventories might bolster economic growth.
Inventories are part of investment. If the fall in inventories
reflects a fall in planned inventories, then planned investment
decreases which decreases aggregate expenditure and real GDP. If the
restocking of inventories is a planned restocking, then planned
investment increases, which boosts aggregate expenditure and real
GDP.
31. Obama’s New Stimulus
The Obama recovery plan announced on Monday includes proposed
spending of $50 billion to rebuild 150,000 miles of roads,
construct and maintain 4,000 miles of rail, and fix or rebuild
150 miles of runways.
Source: USA Today, September 10, 2010
If the slope of the AE curve is 0.7, calculate the immediate
change in aggregate planned expenditure and the change in real
GDP in the short run if the price level remains unchanged.
The increase in government expenditure will have a multiplier effect
on aggregate expenditure and real GDP. The multiplier equals 1/(1 −
the slope of the AE curve). The slope of the AE curve is 0.7 so the
multiplier is 1/(1 − 0.7), which is 3.3. With this multiplier, the
$50 billion increase in government expenditure increases aggregate
expenditure by 3.3 × $50 billion, or $165 billion. In the short run,
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when the price level is constant, real GDP increases by the same
amount, $165 billion.
32. Obama’s Economic Recovery Plan
President Obama's proposal to jolt a listless recovery with $180
billion worth of tax breaks and transportation projects left
economists largely unimpressed Tuesday.
Source: USA Today, September 10, 2010
If taxes fall by $90 billion and the spending on transport
projects increases by $90 billion, which component of Obama’s
recovery plan would have the larger effect on equilibrium
expenditure, other things remaining the same?
The spending on transportation projects will have the larger effect
because the expenditure multiplier is larger than the tax multiplier.
The expenditure multiplier is larger because in the first round all
of the increased government expenditure increases aggregate
expenditure whereas part of a tax cut is saved and hence does not
increase aggregate expenditure.
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33. Price Jump Worst Since ’91
The biggest annual jump in the CPI since 1991 has fanned fears
about growing pressures on consumers. The Labor Department report
confirms what every consumer in America has known for months:
Inflation is soaring and it’s having an adverse impact on the
economy.
Source: CNN, July 16, 2008
Explain and draw a graph to illustrate the effect of a rise in
the price level on equilibrium expenditure.
The jump in inflation means that the price level has soared higher.
The increase in the price level decreases aggregate expenditure
because it decreases real wealth. As shown in Figure 11.5, the
aggregate expenditure curve shifts downward from AE0 to AE1. Because
aggregate expenditure has decreased, real GDP decreases, In Figure
11.5 the decrease in aggregate
expenditure decreases real GDP
from $13.0 trillion to $12.4
trillion.
Use the following news clip to work Problems 34 to 36.
Consumer Sentiment in U.S. Rose to Three Month High
Consumer sentiment was up in August helped by merchant discounts,
especially from auto dealerships who received incentives from
automakers Honda, General Motors, and Toyota to lower prices.
But consumers are worried about the future. They are worried about
tax changes and government budget cuts that are on the horizon.
Capital spending fell somewhat.
Source: Bloomberg, September 1, 2012
34. Which of the expenditures listed in the news clip are part of
induced expenditure and which is part of autonomous expenditure?
Induced consumption expenditure changes with changes in disposable
income. Autonomous consumption expenditure does not change when
disposable income changes. For many consumers, purchasing new cars
increase when their incomes rise. For these consumers, these items
are induced expenditure. Other Americans plan to buy automobiles
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regardless of the change in their income perhaps because their
consumer sentiment is “up,” or perhaps because prices of cars have
fallen. For these consumers, these expenditures are autonomous.
Capital spending is part of autonomous expenditure.
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35. Which of the events reported in the news clip would change
aggregate demand and which would change the quantity of real GDP
demanded? Provide a graphical illustration of the distinction.
The increase in consumption
expenditure induced by increased
income, the autonomous increase
in consumption, and the increase
in capital spending all increase
aggregate demand and shift the
aggregate demand curve rightward.
The increase in consumption
expenditure that results from
lower prices reflects a change
in consumption from a lower
price level and creates a change
in the quantity of real GDP
demanded. Figure 11.6
illustrates these differences.
The change from point A to point
B reflects a change in aggregate
demand. The movement from point
A to point B reflects a change
in the quantity of real GDP demanded.
36. Explain and draw a graph to illustrate how increasing consumer
confidence influences aggregate expenditure and aggregate demand.
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Increasing consumer confidence increases autonomous consumption. It
increases aggregate expenditure and aggregate demand. As illustrated
in Figure 11.7a, the aggregate expenditure curve shifts upward, from
AE0 to AE1 and in Figure 11.7b the aggregate demand curve shifts
rightward, from AD0 to AD1.
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37. Japan Slides Into Recession
In Japan, consumer prices slid at a faster pace in July and
industrial production unexpectedly slumped.
Source: Bloomberg, September 1, 2012
Contrast what the news clip says is happening in Japan with what
is happening in the United States in Problem 34 and provide a
graphical analysis of the differences.
The news clip suggests that in Japan aggregate demand is decreasing
so that both the price level and real GDP are decreasing. Figure
11.8a shows this situation. The information in Problem 34 suggests
that consumption expenditure is increasing and, while investment
(capital spending) is decreasing. However it seems that the change
in consumption expenditure exceeds the change in investment so U.S.
aggregate demand is increasing. Figure 11.8b shows this situation.
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Economics in the News
38. After you have studied Reading Between the Lines on pp. 284–285
(690–691 in Economics), answer the following questions.
a. If the 2012 changes in inventories were mainly planned changes,
what role did they play in shifting the AE curve and changing
equilibrium expenditure? Use a two-part figure (similar to that
on p. 272 (p. 678 in Economics)) to answer this question.
Figure 11.9a shows aggregate planned expenditure; Figure 11.9b shows
unplanned inventory change. When aggregate planned expenditure is
given by AE0, unplanned inventory change is equal to zero when real
GDP is $13.5 trillion, so unplanned inventory change is given by the
top line in Figure 11.9b. If the change in inventories was planned,
then planned investment increased and with it aggregate planned
expenditure also increased. The increase in aggregate planned
expenditure shifts the aggregate expenditure curve upward, as
illustrated by the shift from AE0 to AE1 in Figure 11.9a. It shifts
the unplanned inventory change line downward to the lower curve,
Unplanned inventory change1, in Figure 11.9b. The increase in
aggregate expenditure increases equilibrium real GDP. In figure
11.9a, real GDP increases from $13.5 trillion to $13.6 trillion. In
Figure 11.9b, at real GDP of $13.6 trillion, along the new unplanned
inventory change curve line, unplanned inventory change is zero.
b. The news article reports changes in expenditure on existing
homes and new homes. Explain where each of these expenditures
appear in aggregate planned expenditure.
Changes in expenditure on new homes is counted as part of investment
expenditure. Changes in expenditure on used homes does not appear in
aggregate planned expenditure.
c. Using the assumptions made in Figure 2 on p. 285 (p. 691 in
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Economics), what is the value of the autonomous expenditure
multiplier?
The autonomous expenditure multiplier equals 1/(1 – slope of AE line).
In the figure, the slope along the top red line is equal to ($13.57
trillion − $13.54 trillion)/($13.57 trillion − $13.51 trillion) =
($0.03 trillion)/(($0.06 trillion) = 0.5. So the autonomous
expenditure multiplier equals 1/(1 – 0.5) = 2.0.
38. In an economy autonomous spending is $20 trillion and the slope
of the AE curve is 0.6.
a. What is the equation of the AE curve?
The equation of the AE curve is AE = 20 + 0.6Y, where Y is real GDP
and the 20 is $20 trillion.
b. Calculate equilibrium expenditure.
Equilibrium expenditure is $50 trillion. Equilibrium expenditure is
the level of aggregate expenditure that occurs when aggregate
planned expenditure equals real GDP. That is, AE = 20 + 0.6Y and AE
= Y. Solving these two equations for Y gives equilibrium expenditure
of $50 trillion.
c. Calculate the multiplier if the price level is unchanged.
The multiplier equals 1/(1 − the slope of the AE curve). The
equation of the AE curve tells us that the slope of the AE curve is
0.6. So the multiplier is 1/(1 − 0.6), which is 2.5.
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