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Question 2
a) accumulate; reduce; fall
b) fall; increase; rise
c) investment
d) upward; rise; 45-degree
e) more; simple multiplier (× $10 billion)
f) larger; 1/(1-z)
Question 3
a) The average propensity to consume (APC) is equal to consumption divided by
disposable income. See the completed table below.
YD
C
APC
MPC
0
100
200
300
400
500
600
700
800
150
225
300
375
450
525
600
675
750
--2.25
1.50
1.25
1.125
1.05
1.00
0.96
0.94
--75/100 = 0.75
75/100 = 0.75
75/100 = 0.75
75/100 = 0.75
75/100 = 0.75
75/100 = 0.75
75/100 = 0.75
75/100 = 0.75
b) See the table above. The marginal propensity to consume (MPC) is equal to the change
in consumption divided by the change in disposable income that brought it about. The
MPC is shown as the change from one row in the table to the next.
c) See the figure below. The 45-degree line shows where consumption equals disposable
income. This occurs only once along the consumption function, at the break-even level of
income, Y*, which equals $600. The APC equals one at Y*. The slope of the consumption
function is the MPC, which in this case is 0.75.
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Question 7
a) See the table below.
Y
0
2000
4000
6000
8000
10000
C = 500 + .9Y
I
500 + (.9)0 = 500
500 + (.9)2000 = 2300
500 + (.9)4000 = 4100
500 + (.9)6000 = 5900
500 + (.9)8000 = 7700
500 + (.9)10000 = 9500
100
100
100
100
100
100
AE = C + I
600
2400
4200
6000
7800
9600
b) Equilibrium national income is that level of national income where actual income, Y,
equals desired aggregate expenditure, AE. Thus the equilibrium level of national income is
6000.
c) Desired saving is equal to S = Y - C. When national income is 6000, desired saving is S
= 6000 – 5900 = 100. Note that desired investment is also 100.
To see why S must equal I at the equilibrium level of income, note that the
equilibrium condition is that actual GDP, Y, equals desired aggregate expenditure, AE.
Thus,

Y = AE

Y=C+I
Y–C=I

S=I
Thus stating the equilibrium condition as Y = AE is equivalent to stating it as S = I.
Question 9
a) See the figure below. When wealth is 10000, the AE function is
AE = 500 + 0.75Y + (.05)(10000) + 150  AE = 1150 + 0.75Y
Using the equilibrium condition, Y = AE, the equilibrium level of national income is the
level of Y that solves the following equation:
Y = 1150 + 0.75Y  Y(1 – 0.75) = 1150  Y = 1150/.25  Y = 4600
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b) The value of the simple multiplier is 1/(1 – MPC). In this economy, MPC = 0.75 and so
the value of the simple multiplier is 1/(1 – 0.75) = 1/(0.25) = 4.
c) If desired investment increases from 150 to 250, this is an increase in autonomous
expenditure of 100. Given the multiplier of 4, the change in equilibrium national income
will be 400. This is shown in the diagram above as the AE function shifts to AE and
equilibrium national income rises to 5000.
d) Let’s suppose that I has already increased to 250 as in part (c). If wealth now increases
from 10000 to 15000, the level of autonomous consumption increases by 5000(.05) = 250.
Thus the new AE function becomes
AE = 1500 + (.75)Y
As households increase their autonomous consumption by 250, the AE function shifts up by
250 and the equilibrium level of national income increases by 250×4 = 1000. Equilibrium
national income rises to 6000.
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