Download Chapter 10 The Short-Run Macro Model

Chapter 10 The Short-Run Macro Model
Review Questions
2. The marginal propensity to consume is (1) the slope of the consumption function; (2) the
change in consumption divided by the change in disposable income; or (3) the amount by
which consumption spending rises when disposable income rises by one dollar.
4.
The two components of planned investment or investment spending are business
purchases of plant and equipment and new home construction. Actual investment
includes these two categories as well as changes in business inventories.
6.
8.
If government spending increases, then firms that sell goods and services to the
government will earn additional revenue, which will end up going to the factors of
production that produced those goods, increasing household income. The increase in
income leads households to increase spending, increasing the revenue of firms that
produce consumption goods. Income increases once again, leading to a further increase
in spending, and so on. In the end, GDP will rise by a multiple of the increase in
government spending.
An automatic stabilizer is a force that interferes with, and reduces the size of, the
multiplier effect. Some automatic stabilizers for the U.S. economy include taxes, transfer
payments, interest rates, prices, imports, and consumer behavior.
10. No. In the classical long-run model, fiscal policy is completely ineffective due to the
crowding out effect. In the short-run macro model, however, an increase in
government purchases causes a multiplied increase in equilibrium GDP.
Problems and Exercises
2.
a.
Real GDP
Autonomous
Consumption
MPC x Disposable
Income
Consumption =
Autonomous
Consumption + (MPC
x Disposable Income)
$0
$100
$200
$300
$400
$500
$600
$30
$30
$30
$30
$30
$30
$30
$0
$85
$170
$255
$340
$425
$510
$30
$115
$200
$285
$370
$455
$540
b.
Real GDP
Consumption
Spending
Planned
Investment
Government
Spending
Net Exports
Aggregate
Expenditures
$0
$100
$200
$300
$400
$500
$600
$30
$115
$200
$285
$370
$455
$540
$40
$40
$40
$40
$40
$40
$40
$20
$20
$20
$20
$20
$20
$20
-$15
-$15
-$15
-$15
-$15
-$15
-$15
$75
$160
$245
$330
$415
$500
$585
c.
d. $500 billion is the equilibrium level of real GDP.
e. If the actual level of real GDP in this economy is $200 billion, then the economy will
expand. This is because aggregate expenditures ($245 billion) are greater than real
GDP ($200 billion), so firms find their inventories falling, and will expand output,
leading to a higher real GDP in the future.
f. If planned investment falls to $25 billion, the equilibrium level of real GDP will fall
from $500 billion to $400 billion.
4.
a. Inventories will unexpectedly fall; sending firms the signal to produce more output.
GDPA is not sustainable because the extra production will move the economy to the
right along the horizontal axis.
b. Inventories will unexpectedly rise; sending firms the signal to produce less output.
GDPB is not sustainable because cut in production will move the economy to the left
along the horizontal axis.
6.
a.
b.
c.
d.
Real GDP and total employment will increase.
Real GDP and total employment will increase.
Real GDP and total employment will decrease.
Real GDP and total employment will increase.
8.
a. In the table in Problem 2, the second column (C) would be affected; each number in
the column would become smaller, since households would spend less at each level
of income.
b. The change in saving is the vertical distance between the aggregate expenditure lines.
c.
Real
Aggregate
Expenditure
(C + I + NX) 1
(C + I + NX) 2
45°
Y2
Y1
Real
GDP
10. a. If the MPC is 0.95, then the expenditure multiplier is 20. Therefore, the change in
real GDP is 20 x $7500 = $150,000.
b. If the MPC is 0.65, then the expenditure multiplier is 2.86. Therefore, the change in
real GDP is 2.86 x -$300 thousand = -$858 thousand.
c. If the MPC is 0.75, then the expenditure multiplier is 4. Therefore, the change in real
GDP is 4 x -$5 billion = -$20 billion.
12.
a. The change in real GDP = (-0.75/(1 – 0.75)) x $400 thousand = -$1200 thousand.
b. The change in real GDP resulting from the tax cut = (-0.60/(1-0.60)) x -$500
thousand = $750 thousand. The change in real GDP resulting from the cut in
government spending = (-1/(1 – 0.60)) x -$500 thousand = -$1250 thousand. The net
change in real GDP = $750 thousand + -$1250 thousand = -$500 thousand.
Challenge Questions
2.
Y = [a – (b  T) + IP + G + NX] / (1 – b) = [1000 – (0.65 x 700) + 800 + 600 - 200] / (1 –
0.65) = 4,985.71. At this equilibrium, C = a + b(Y – T) = 1000 + 0.65(4985.71 – 700) =
3,785.71. Therefore, in equilibrium, we have aggregate expenditure = C + IP + G + NX =
3,785.71 + 800 + 600 - 200 = 4,985.71, which is equal to equilibrium real GDP.
4.
No. Whenever government spending and taxes change by the same amount, real GDP
changes by that same amount.