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CHAPTER 9 Building the Aggregate Expenditures Model A. Short-Answer, Essays, and Problems New 1. What are the simplifying assumptions for this chapter? What are two implications from these simplications? 2. Define the consumption and saving schedules. 3. Explain how consumption and saving are related to disposable income in the aggregate expenditures model. 4. Complete the following table assuming that (a) MPS = 1/5, (b) there is no government and all saving is personal saving. Level of output and income $250 275 300 325 350 375 400 Consumption $260 ____ ____ ____ ____ ____ ____ Saving $___ ___ ___ ___ ___ ___ ___ 5. Complete the following table assuming that (a) MPS = 1/3, (b) there is no government and all saving is personal saving. Level of output and income $100 130 160 190 220 250 Consumption $120 ____ ____ ____ ____ ____ Saving $___ ___ ___ ___ ___ ___ 6. Differentiate between the average propensity to consume and the marginal propensity to consume. 7. What are the marginal propensity to consume (MPC) and marginal propensity to save (MPS)? How are the two concepts related? How are the two concepts related to the consumption and saving functions? 115 Chapter 9 8. Suppose a family’s annual disposable income is $8,000 of which it saves $2,000. (a) What is their APC? (b) If their income rises to $10,000 and they plan to save $2,800, what are their MPS and MPC? (c) Did the family’s APC rise or fall with their increase in income? 9. Complete the accompanying table. Level of output and income (GDP = DI) Consumption $480 $___ 520 ___ 560 ___ 600 ___ 640 ___ 680 ___ 720 ___ 760 ___ 800 ___ Saving $–8 0 8 16 24 32 40 48 56 APC ____ ____ ____ ____ ____ ____ ____ ____ ____ APS ____ ____ ____ ____ ____ ____ ____ ____ ____ MPC ___ ___ ___ ___ ___ ___ ___ ___ ___ MPS ___ ___ ___ ___ ___ ___ ___ ___ ___ (a) Using the below graphs, show the consumption and saving schedules graphically. 116 Building the Aggregate Expenditures Model (b) Locate the break-even level of income. How is it possible for households to dissave at very low income levels? (c) If the proportion of total income consumed decreases and the proportion saved increases as income rises, explain both verbally and graphically how the MPC and MPS can be constant at various levels of income. 10. Complete the accompanying table. Level of output and income (GDP = DI) Consumption $100 $___ 125 ___ 150 ___ 175 ___ 200 ___ 225 ___ 250 ___ 275 ___ 300 ___ Saving $–5 0 5 10 15 20 25 30 35 APC ____ ____ ____ ____ ____ ____ ____ ____ ____ APS ____ ____ ____ ____ ____ ____ ____ ____ ____ MPC ___ ___ ___ ___ ___ ___ ___ ___ ___ MPS ___ ___ ___ ___ ___ ___ ___ ___ ___ (a) What is the break-even level of income? How is it possible for households to dissave at very low income levels? (b) If the proportion of total income consumed decreases and the proportion saved increases as income rises, explain how the MPC and MPS can be constant at various levels of income. 11. List four factors which could shift the consumption schedule. New 12. What is the effect of increase in wealth on the consumption and saving schedules? New 13. Other things being constant, what will be the effect of each of the following upon the equilibrium level of GDP? (a) An increase in the amount of liquid assets consumers are holding (b) A sharp rise in stock prices (c) A rapid upsurge in the rate of technological advance (d) A sharp increase in the interest rate New 14. Explain the difference between a movement along the consumption schedule and a shift in the consumption schedule. 117 Chapter 9 15. Use the graphs below to answer the following questions: (a) What types of schedules do graphs A and B represent? (b) If in graph A line A2 shifts to A3 because households consume more and this change is not due to changing taxes, then in graph B, what would happen to line B2? (c) If in graph B, line B2 shifts to B1 because households save less, then in graph A, what will happen to line A2? (d) In graph A, what has caused the movement from point A to point B on line A2? (e) If there is a lump-sum tax increase causing line A2 to shift to A1, then in graph B, what will happen to B2? 16. Describe the relationship shown by the investment demand curve. 17. Use the following data to answer the questions. Expected rate of return Cumulative amount of investment (billions) 11% 10 8 5 3 1 $55 75 90 105 150 190 (a) Explain why this table is essentially an investment demand schedule. (b) If the interest rate was 8%, how much investment would be undertaken? (c) Why is there an inverse relationship between the rate of interest and the amount of investment? 18. List five events that could cause a shift in the investment demand curve. 118 Building the Aggregate Expenditures Model 19. What is the difference between the investment-demand curve and the investment schedule for the economy? 20. State four factors that explain why investment spending tends to be unstable. 21. Compare the determinants of the consumption schedule and the investment schedule. Most economists regard the investment schedule as being less stable than the consumption schedule. Looking at the determinants of the two schedules, support this contention. 22. Define the equilibrium level of output. New 23. Explain why saving equals planned investment at equilibrium GDP. 24. Explain the difference between an equilibrium level of GDP and a level of GDP which is in disequilibrium. 25. In a graph relating private spending (C + Ig ) to real gross domestic product (GDP), what does the 45-degree line represent? 26. Use the graph below to explain the determination of equilibrium GDP by the aggregate expenditures-domestic output approach. At equilibrium C + Ig = Real GDP ($550 + $50 = $600). Why does the intersection of the aggregate expenditures schedule and the 45degree line determine the equilibrium GDP? 27. What differentiates the planned equilibrium level of investment from disequilibrium levels of investment? Explain. 28. Explain the difference between planned and actual investment in the economy. Why is the distinction important? 29. What is the relationship between actual investment, planned investment, and saving in an economy? What conditions among these concepts produce equilibrium? 119 Chapter 9 New 30. (Last Word) Explain Say’s law. New 31. (Last Word) “If production results in income and income is the source of spending, it would seem that the production of a full-employment economy would automatically guarantee enough spending to sustain itself. How, then, can unemployment occur?” Explain. New 32. (Last Word) What two events undermined the theory that supply creates its own demand? New 33. (Last Word) Contrast the classical and Keynesian views of unemployment. 34. Advanced analysis: Suppose that the linear equation for consumption in a hypothetical economy is C = 50 + 0.9 Y. Also suppose that income (Y) is $400. Determine the following: (a) MPC; (b) MPS; (c) level of consumption; (d) APC; (e) APS. 120