Econ 001 Exam 3

Holding everything else constant, the multiplier effect for taxes is _____ that for changes in autonomous aggregate spending.

less than

The interest rate effect states that as the aggregate price level decreases, all else equal, people demand _____ money, which drives the interest rate _____ and investment _____.

less; down; up

In a macroeconomic context, what are implicit liabilities? Which of the choices is a significant implicit liability in the United States?

money that the government has promised to pay in the future Social Security

Which tax is the largest source of tax revenue in the United States?

personal income taxes

What type of spending depends primarily on these three factors: the interest rate, the expected future level of real GDP, and the current level of production capacity?

planned investment spending

If the Federal Reserve increases interest rates to reduce inflation, other things equal:

planned investment spending is most likely to decrease.

The long-run level of output is known as _____ output.

potential

Suppose that the U.S. economy is in a severe recession. Most households are trying to save more of their income than before. This increase in private savings will lead to:

a fall in real GDP, as more savings means people will spend less.

An example of an automatic stabilizer that takes effect when the economy contracts is a:

rise in government transfers as more people receive unemployment insurance benefits.

Which asset is NOT included in M1?

savings deposits

The Glass-Steagall Act of 1933:

separated banks into two categories, commercial and investment.

Money is anything that:

serves as a medium of exchange for goods and services.

If there is a recessionary gap, discretionary fiscal policy would likely include action to:

shift the aggregate demand curve to the right.

(Figure: Income-Expenditure Equilibrium) Use Figure: Income-Expenditure Equilibrium. If planned investment spending increases in this economy:

the aggregate spending line will shift up, increasing the income-expenditure equilibrium GDP.

If the marginal propensity to save decreases from 0.6 to 0.5:

the slope of the consumption function decreases from 0.6 to 0.5.

Suppose you find a $50 bill that you put in a coat pocket last winter. If you deposit it in your checking account:

there is no change in M1 or M2.

Banks don't lend out all funds that are deposited because:

they have to satisfy any depositor who wants to withdraw funds.

The medium-of-exchange function means that money is used:

to pay for goods and services.

Which asset is the MOST liquid?

currency

(Scenario: Money Supply Changes II) Lucia withdraws $6,000 from her checking account to pay tuition this semester. Assume that the reserve requirement is 20% and that banks do not hold excess reserves. As a result of the withdrawal, required reserves:

decrease by $1,200.

How do automatic stabilizers impact tax revenue and government spending during a recession? Tax revenue will __________ and government spending will ___________.

decrease; increase

Under the Glass-Steagall Act, commercial banks, which accept deposits and are covered by _____ insurance, were not allowed to trade in _____.

deposit; financial assets such as stocks and bonds

If Medicaid is expanded to cover a greater percentage of the population:

implicit liabilities will increase.

If aggregate output is less than potential output, the economy is:

in a recessionary gap.

The central bank of the United States is called the:

Federal Reserve Bank.

The statements regarding savings and loans (S&Ls) are all true EXCEPT

S&Ls are not covered by federal deposit insurance.

Which equation represents the government budget balance MOST accurately?

T - G - TR

The government's budget balance is:

T - G - TR.

Suppose the government decreases taxes. What will happen to disposable income and consumer spending? a. Disposable income b. Consumer spending will

a. increases b. increase

Time lags make:

the effective use of both fiscal and monetary policy challenging.

The shadow banking system refers to

the unregulated non-bank financial firms engaged in borrowing from investors and lending to households and firms

An asset is _____ if it is easily convertible into cash with little or no loss of value.

liquid

Consider the graphical representation of the Keynesian cross for a hypothetical country, where the planned aggregate spending line is graphed against the 45° line. Suppose that, in this country, there is an autonomous increase in aggregate spending of $20 billion$20 billion. Show this change on the graph. Consider the graphical representation of the Keynesian cross for a hypothetical country, where the planned aggregate spending line is graphed against the 45°45° line. Suppose that, in this country, there is an autonomous increase in aggregate spending of $20 billion$20 billion. Show this change on the graph. What is the initial unplanned inventory investment? If the number is negative, be sure to include a negative sign. After firms adjust their production, what is the total change in real GDP? If the number is negative, be sure to include a negative sign.

graph endpoints: (0, 60) (200, 160) initial unplanned inventory investment: $ -20 billion total change in real GDP: $ 40 billion

The accompanying graph illustrates an economy in long-run equilibrium which is denoted by point ELR. Suppose a new technology is discovered which increases productivity. In the graph, demonstrate how the economy moves to its new long-run equilibrium by shifting the appropriate curves and placing point ELR at the new long-run equilibrium. In the long run, the aggregate price level __________ and real GDP (aggregate output) __________.

graph: LRAS and SRAS moved right; E intersects decreases; increases

Alice's disposable income increases by $1,000, and she spends $600 of it. Assuming no taxes, Alice's:

marginal propensity to save is 0.4, and she saves $400.

Lilliput is a country that has closed borders and does not import or export any goods or services; hence, they do not worry about trade with other countries. Total spending for the federal government of Lilliput for the last fiscal year was $1.06$1.06 billion. The country collected $1.05$1.05 billion in taxes during this same fiscal year. Assume government transfers were zero. Based on this information, what is Lilliput's budget balance? Enter your answer to two decimal places. In the last fiscal year, Lilliput was running

budget balance: $ .01 billion a budget deficit

(Figure: Short-Run Equilibrium) Use Figure: Short-Run Equilibrium. The economy is in short-run equilibrium. To move the economy to potential output, the government should reduce its spending by an amount equal to:

(Y1 - YP)(1 - MPC).

_____ will shift the aggregate demand curve.

A demand shock

(Figure: Fiscal Policy II) Use Figure: Fiscal Policy II. Suppose that this economy is in equilibrium at E1. If there is a decrease in government purchases, _____ will shift to the _____, causing a(n) _____ in the price level and a(n) _____ in real GDP.

AD1; left; decrease; decrease

Why are persistent budget deficits worrisome?

All of the above.

Suppose disposable income increases by $2,000$2,000. As a result, consumption increases by $1,500$1,500. Answer the questions based on this information. Where appropriate, enter your answer as a decimal rather than as a percentage. The increase in savings resulting directly from this change in income is The marginal propensity to save (MPS) is The marginal propensity to consume (MPC) is

Change in income: $500 ($2000- $1,500= $500) MPS: 0.25 ($500/$2000=0.25) MPC: 0.75 (1- 0.25= 0.75)

Which of the statements is not true about a bank run?

Bank runs are bad for the bank affected and usually good for the bank's competitors.

During the Great Depression:

both consumption and investment decreased.

If the multiplier equals 4, then the marginal propensity to save must be equal to:

0.25

In a simple, closed economy (no government or foreign sector), disposable income decreases from $6,000 to $4,000. If consumption decreases from $4,500 to $3,000, the marginal propensity to consume is:

0.75

The Federal Reserve System was established in:

1913.

Fiscal Policy — End of Chapter Problem Most macroeconomists believe that it is a good thing that taxes act as automatic stabilizers and lower the size of the multiplier. However, a smaller multiplier means that changes in government purchases of goods and services, government transfers, or taxes necessary to close inflationary or recessionary gaps are larger. How can you explain this apparent inconsistency?

Automatic stabilizers dampen the business cycle. Any change in autonomous spending would result in a smaller inflationary or recessionary gap. Although the effect of discretionary fiscal policy would be reduced, the need for discretionary fiscal policy would also be reduced.

Identify how planned investment will change in each scenario. Airwings, a commercial airline manufacturer, becomes optimistic about economic conditions after seeing reports of strong growth in consumer spending. The Federal Reserve announces an end to accommodative monetary policy, and is now implementing policy tools that will increase the real interest rate. In an effort to reduce constant budget deficits, Congress announces plans to increase the corporate income tax rate. A major recession has reduced consumption spending, which has hurt profit levels for Aston-Benz, a high-end car manufacturer.

Due to Airwings, planned investment increase. Due to the Fed, planned investment decrease. Due to the Congress, planned investment decrease. Due to the recession, planned investment decrease.

In the accompanying graph, illustrate the impact of an increase in the contracted nominal wage. How do nominal wage changes affect the economy's output at the long-run equilibrium?

Graph: left shift Nominal wages have no impact on output in the long run.

(Scenario: Assets and Liabilities of the Banking System) If the required reserve ratio is 6%, and the banking system does NOT want to hold excess reserves, how much more can be added to the money supply? Scenario: Assets and Liabilities of the Banking System Assets Liabilities Loans $1,800,000 Deposits $2,000,000 Reserves 200,000

about $1,333,333

If the required reserve ratio rises:

banks must keep a larger share of each deposit in reserve.

Complete the statements and then calculate the change in consumption. The consumption function shows the relationship between consumption spending and ___________________. The slope of the consumption function is the __________________. Changes in consumption can be predicted by multiplying the change in _________ by the _____________. If the MPC=0.80 and disposable income increases by $1000, then consumption will increase by what amount? Assume that there is no multiplier effect.

disposable income marginal propensity to consume disposable income; marginal propensity to consume $800

As a recessionary gap self-corrects, the equilibrium price level _____, and the equilibrium aggregate output _____.

falls; increases

A double coincidence of wants is necessary:

for barter exchange.

Consumer spending will likely rise if:

government transfers rise.

The full employment level of real GDP is $6 billion for the recently formed island nation of Turtleopolis. Use the line segment to show long‑run aggregate supply on the graph.

graph endpoint: (6, 0) (6, 8)

Move the short-run aggregate supply (SRAS) curve and/or the aggregate demand (AD) curve in the accompanying graph to demonstrate a negative supply shock. Which of the following is most associated with a negative supply shock?

graph: SRAS moved left Stagflation

Adjust the graph to show the effect of a decrease in the aggregate price level. Which of the statements offers the best explanation for the change demonstrated in the graph?

graph: move point A down Prices of goods and services decrease on average.

Suppose that the economy is in a recessionary gap. A $100 billion _____ is likely to increase real GDP by the LARGEST amount.

increase in government purchases

The interest rate effect leads to a downward-sloping aggregate demand curve because a lower price level causes consumer spending to _____ and investment to _____.

increase; increase

If Kelly transfers $500 from her savings account to her checking account, M1 will _____ and M2 will ______.

increase; remain the same

A cut in taxes _____, shifting the aggregate demand curve to the _____.

increases disposable income and consumption; right

When the aggregate price level _____, firms in perfectly competitive markets usually experience a(n) _____ in profit per unit and _____ output.

increases; increase; increased

If overall spending declines, causing the economy to contract, the government could counter this by:

increasing government spending.

Suppose a firm has enough retained earnings to finance an investment project. For this firm, the market interest rate:

indicates the opportunity cost of using retained earnings.

(Figure: Short- and Long-Run Equilibrium II) Use Figure: Short- and Long-Run Equilibrium II. If the economy is in short-run macroeconomic equilibrium at E1, it is in a(n):

inflationary gap.

Inventories are counted as _____ because inventories are a source of future sales.

investment

The interest rate effect

is the change in consumer and investment spending due to changes in interest rates resulting from changes in the aggregate price level.

The long-run supply curve shows that aggregate output supplied _____ the aggregate price level in the long run.

is unrelated to

The marginal propensity to consume:

is usually higher for unemployed individuals than for people who are very wealthy.

Discretionary fiscal policy may fail to stabilize the economy and even destabilize it because of:

lags in decisions regarding the implementation of policy changes.

Suppose that the required reserve ratio is 8.008.00%. What is the simple money (deposit) multiplier? Round to two decimal places. Increasing the reserve ratio will _____ the money multiplier.

money multiplier: 12.50 decrease

In the consumption function, an individual household's consumer spending is:

positively related to its current disposable income.

The short-run aggregate supply curve will shift to the:

right if nominal wages decrease.

An increase in aggregate demand is seen as a(n) _____ the aggregate demand curve.

shift to the right of

Throughout history, all sorts of interesting things have been used as money, including fresh fish and cattle. Fresh fish is not an effective form of money. What essential characteristic of money does fresh fish lack that most makes it ineffective? Cattle is not an effective form of money. What essential characteristic of money does cattle lack that most makes it ineffective?

store of value unit of account

Fiscal policy is conducted by _________ and involves ___________.

the federal government; government spending and taxes

The economy is self-correcting in ____.

the long run only

The greater is the production capacity of the economy:

the lower is planned investment spending.

Assume that the marginal propensity to consume is 0.8 and potential output is $800 billion. If GDP is $850 billion:

there is an inflationary gap.

Figure: The Multiplier) Use Figure: The Multiplier. If real GDP is Y1, and the price level decreases:

there will be a downward movement along AD1, reflecting a decrease in the price level.

Planned aggregate expenditure is represented by a line that is:

upward sloping.

(Table: Aggregate Spending) Use Table: Aggregate Spending. Suppose the economy has no government spending and no foreign trade. With no taxes or transfers, real GDP equals disposable income (YD). At what level of real GDP will the economy find its income-expenditure equilibrium? Table: Aggregate Spending Real GDP YD Consumption I planned 0 0 100 600 500 500 500 600 1000 1000 900 600 1500 1500 1300 600 2000 2000 1700 600 2500 2500 2100 600 3000 3000 2500 600 3500 3500 2900 600 4000 4000 3300 600

$2,000

Assume a closed economy with no government and a fixed aggregate price level and constant interest rate. Furthermore, assume that the country's consumption function is C = 200 + 0.75YD, where YD is disposable income, and C is consumption, and that planned investment is $75. What is the income-expenditure equilibrium GDP for this country?

$200

Suppose that the aggregate consumption function is given by the equation C = 200 + 0.8YD, where C represents consumption, and YD represents disposable income. If disposable income increases from $500 to $800, autonomous consumption is:

$200.

What is the eventual effect on real GDP if the government increases its purchases of goods and services by $50,000? Assume the marginal propensity to consume (MPC) is 0.75. What is the eventual effect on real GDP if the government, instead of changing its spending, increases transfers by $50,000? Assume the MPC has not changed. An increase in government transfers or taxes, as opposed to an increase in government purchases of goods and services, will result in

$200000 $150000 a smaller eventual effect on real GDP.

Suppose banks increase excess reserves by $987581987581. If the reserve ratio is 4.04.0 percent, what is the maximum increase in the money supply? Round your answer to the nearest dollar.

$24689525

(Table: Monetary Aggregates II) Use Table: Monetary Aggregates II. The value of M2 is: Table: Monetary Aggregates II Monetary Aggregates (in billions) Currency in circulation $700 Money market funds 550 Time deposits 800 Savings deposits 1,110 Checkable bank deposits 380 Traveler's checks 15 American Express gift cards 25

$3,555 billion.

The tables show the spending and revenue for Littleland in 2010. Use the tables and other information to answer the questions. Spending category Value (millions) education $ 320 welfare and Social Security $ 890 health care $ 270 defense $ 120 payments on debt $ 170* other $ 240 *This payment covers total interest owed only Revenue category Value (millions) income tax $ 800 sales tax $ 270 corporate tax $ 300 social insurance $ 340 GDP in 2010: $7.3 billion Total debt as of 2009: $3.5 billion How much money (in millions) did Littleland need to borrow in 2010 to finance its government spending? At the end of 2010, what was Littleland's debt to GDP ratio? Give your answer to the nearest whole percentage point.

$300 million money borrowed=total spending−total revenue money borrowed=($320+$890+$270+$120+$170+$240)−($800+$270+$300+$340) =$2,010−$1,710 =$300 52% deficit to GDP ratio=total deficit/GDP ratio =$300/$7,300×100% =4% debt to GDP ratio=total debt/GDP ratio =$3,800/$7,300×100% =52%

Suppose that Kim K decides to spend $30,000 on an American‑made purse instead of donating it to Haitian earthquake relief. Assume that the multiplier is 1.21.2. How much will GDP rise when Kim K buys her purse according to the multiplier effect? Buying the purse increases America's GDP ________ donating the money to Haitian earthquake relief. Suppose she instead donated to tornado relief in Joplin, MO. Buying the purse increases GDP _________ spending on tornado relief.

$36,000 increase in GDP=original increase in spending×multiplier =$30,000×1.2 =$36,000 more than; about the same amount as

Suppose that in 2020, Airbus Co. purchased $400 million worth of raw materials to manufacture airplanes valued at $900 million. In that year, Airbus Co. sold airplanes valued at $800 million in total. During 2020, Airbus Co. registered inventory investment of:

$400 million.

(Figure: Consumption and Real GDP) Use Figure: Consumption and Real GDP. If real GDP is $12 trillion, consumption is _____ trillion.

$7

(Scenario: First National Bank) First National Bank has $160 million in checkable deposits, $30 million in deposits with the Federal Reserve, $10 million cash in the bank vault, and $10 million in government bonds. Given the bank's minimum reserve ratio of 20% and a goal of holding zero excess reserves, how much can the bank issue in additional loans?

$8 million

Suppose that a bank receives a new deposit of $200 in cash and that the required reserve ratio is 20%. If the bank lends the maximum amount of money allowed, then the money supply (excluding the original deposit) increases by:

$800.

The Thompson family has a disposable income of $90,000 annually. Currently, the Thompson family spends 80% of new disposable income on consumption. Assume that their marginal propensity to consume is 0.8 and that their autonomous consumption spending is equal to $10,000. What is the amount of the Thompson family's annual consumer spending?

$82000 𝑐=𝑎𝑐+(MPC× yd) =$10,000+(0.8×$90,000) =$10,000+$72000 =$82000

If your disposable personal income increases from $10,000 to $15,000, and your consumption increases from $9,000 to $13,000, your marginal propensity to consume is:

0.8

In a simple, closed economy (no government or foreign sector), if the marginal propensity to save is 0.2, the marginal propensity to consume must be:

0.8

Classify the statements about the European Central Bank (ECB) as true or false. 1. The ECB controls monetary policy in all European countries. 2. The ECB is the oldest central bank in existence. 3. The ECB regulates the supply of Euros. 4. The ECB is relatively insulated from political pressure. 5. The Federal Reserve System and the ECB have a similar design and purpose. 6. Because of the existence of the ECB, the countries of the European Union do not have national banks.

1. f 2. f 3. t 4. t 5. t 6. f

If the marginal propensity to consume is 0.6, the multiplier for government purchases of goods and services will be:

2.5.

You are an economic adviser to a candidate for national office. She asks you for a summary of the economic consequences of a balanced-budget rule for the federal government and for your recommendation on whether she should support such a rule. Which of the following responses is consistent with macroeconomic theory?

Adopting a balanced-budget rule is not recommended. Balanced-budget rules prevent the government from using taxes and transfers as automatic stabilizers since these policies tend to result in deficits and surpluses.

Which of the statements best describes why the aggregate demand curve is downward sloping?

An increase in the aggregate price level causes consumer and investment spending to fall, because consumer purchasing power decreases and money demand increases.

Suppose that the least amount of goods and services that Roberto will consume in a year is $40,000. Roberto tends to save $0.30 of every dollar of disposable income that he makes. Use the given line to graph Roberto's consumption function for disposable income levels between $0 and $200,000. Move each endpoint to the appropriate spot on the graph.

Endpoints on (0,40) (200,180)

The accompanying graph represents the aggregate consumption function for the small island nation of Pineapple Paradise. The people of Pineapple Paradise expect their future disposable income to increase. Use the graph to show an increase in consumption expenditures. What is the new level of aggregate autonomous consumer spending?

Graph endpoints: (1000, 4000) and (10000, 8000) $4000

Which of the following functions pertains to the Federal Reserve System? I. conducting monetary policy II. examining and supervising commercial banks within Fed regions III. providing liquidity to financial institutions

I, II, and III

Which of the statements about subprime lending is false?

If a home owner is unable to afford the mortgage payments, the homeowner can always pay off the mortgage by selling the home.

What was the main financial problem that the government of Greece faced in 2009?

It had a large budget deficit, but most of its creditors were unwilling to make loans to Greece or charged extremely high interest rates to compensate them for the risk of loss.

Calculate the values for each of the questions. Assume that in each country there are no taxes, international trade, or inflation and that interest rates are fixed. The Italian government decides to stimulate the economy by sending checks worth $70 billion to Italian consumers. If the government spending multiplier is 1.5, calculate the MPC to determine the final change in Italy's real GDP due to the transfer. Please give your answer as a whole number in billions of dollars. The Greek government decides to introduce new austerity measures, which reduce government direct spending by $16 billion. Greece has a marginal propensity to consume of 0.6. What will be the final change in real GDP as a result of this decreased spending? Please give your answer as a whole number in billions of dollars. The Japanese government decides to stimulate the economy by increasing direct spending by $70 billion. If the final change in real GDP is $280 billion, what is Japanese consumers' marginal propensity to consume (MPC)? Please round your answer to two decimal places.

Italy: 35 1/MPS= 1.5 1.5 * MPS= 1 MPS= 1/1.5 MPS= 0.66 1- MPS= MPC 1- 0.66= MPC = 0.33 MPC×the transfer payment=change in consumer spending 0.33×$70 billion=$23.1 billion increased spending×multiplier=increased real GDP $23.1 billion×1.5=$34.65 billion, rounded=$35 billion Greece: -40 Multiplier=1/1−MPC =1/1−0.6 =1/0.4 =2.5 change in real GDP=$16 billion×−2.5=−$40 billion Japan: 0.75 multiplier=1/1−MPC=4 or MPC=0.75

The terms are measures or individual components of the money supply. Place these items from largest to smallest in terms of dollar value, specifically considering the money supply of the United States.

Largest M2 balances in savings accounts M1 currency travelers checks Smallest

Income and Expenditure — End of Chapter Problem From 2014 to 2019, Eastlandia experienced large fluctuations in both aggregate consumer spending and disposable income, but wealth, the interest rate, and expected future disposable income did not change. The accompanying table shows the level of aggregate consumer spending and disposable income in millions of dollars for each of these years. Use this information to answer the following questions. Year Disposable income Consumer spending 2014 $100 $180 2015 350 380 2016 300 340 2017 400 420 2018 375 400 2019 500 500 a. What is the marginal propensity to consume? What is the marginal propensity to save? b. What is the aggregate consumption function? Let y denote disposable income.

MPC: 0.8 MPS: 0.2 c= 100 + 0.8 *y

You are Chair of the Federal Reserve Board. In your meeting with the Federal Open Market Committee, the committee unanimously votes to increase the money supply using open market operations (OMOs). During the press conference after the meeting, a reporter asks you to explain what OMOs are and how you will use them to increase the money supply. You reply that

OMOs are the selling and buying of government securities. The money supply increases when purchasing occurs and contracts when selling occurs. OMOs work by changing the amount of excess reserves available in the banking system.

(Figure: Aggregate Supply Movements) Use Figure: Aggregate Supply Movements. Which statement is correct?

Short-run aggregate supply has increased.

(Figure: Aggregate Supply Movements) Use Figure: Aggregate Supply Movements. Which statement is correct?

Short-run aggregate supply increases because of increased productivity.

Rather than simply comparing government revenues and tax receipts, analysts are sometimes interested in the "cyclically adjusted" budget balance. What does it mean to consider the cyclically adjusted budget balance?

The cyclically adjusted budget balance accounts for what the budget balance would be in terms of the total value of goods and services produced in an economy at the potential output.

The difference between a budget deficit and government debt is that:

a deficit is the amount by which government spending exceeds tax revenues, whereas debt is the sum of money the government owes.

Fiscal Policy — End of Chapter Problem In the following case, either a recessionary or inflationary gap exists. Assume that the aggregate supply curve is horizontal so that the change in real GDP arising from a shift of the aggregate demand curve equals the size of the shift of the curve. Calculate the magnitude of both the change in government purchases of goods and services and the change in government transfers necessary to close the gap. Real GDP equals $100 billion, potential output equals $160 billion, and the marginal propensity to consume is 0.75. The economy faces ________ gap. To close the gap, government spending and/or transfers would need to __________. Spending would need to change by $ ________ billion to close the gap. Transfers would need to change by $ ___________ billion to close the gap.

a recessionary; increase Spending: 15 Transfer: 20

The primary cause of the recession that ended in late 2001 was:

a slump in business investment spending.

Income and Expenditure — End of Chapter Problem The U.S. economy slowed significantly in early 2008, and policymakers were extremely concerned about growth. To boost the economy, Congress passed relief packages (the Economic Stimulus Act of 2008 and the American Recovery and Reinvestment Act of 2009) that, combined, would deliver about $700 billion in government spending to the economy. Assume, for the sake of argument, that this spending took the form of payments made directly to consumers with the objective of boosting the economy by increasing the disposable income of American consumers. a. If the marginal propensity to consume (MPC) in the United States is 0.5, the initial change in aggregate consumer spending as a consequence of this policy measure would be ____________. The resulting change in real GDP due only to the change in consumer spending would be __________. b. Using the accompanying graph, illustrate the effect on real GDP by shifting the planned aggregate expenditure curve. Show the effect of the autonomous policy change on the equilibrium by moving the equilibrium point.

a. $350 billion; $700 billion b. AE: move up E: move to intersect

Fiscal Policy — End of Chapter Problem During a 2008 interview, then-German Finance Minister Peer Steinbrueck said, "We have to watch out that in Europe and beyond, nothing like a combination of downward economic [growth] and high inflation rates emerge—something that experts call stagflation." Such a situation can be depicted by the movement of the short-run aggregate supply curve from its original position, SRAS1, to its new position, SRAS2, with the new equilibrium point E2 in the accompanying figures. In this question, we try to understand why stagflation is particularly hard to fix through fiscal policy. a. What would be the appropriate fiscal policy response to this situation if the primary concern of the government were to maintain economic growth? Illustrate the effect of this policy on the equilibrium point and the aggregate price level by shifting the aggregate demand (AD) curve and placing point E3 appropriately in diagram a. b. What would be the appropriate fiscal policy response to this situation if the primary concern of the government were to maintain price stability? Illustrate the effect of the policy on the equilibrium point and the aggregate price level by shifting the AD curve and placing point E3 appropriately in diagram b. c. Which of the following statements accurately summarizes the effectiveness of fiscal policies in fighting stagflation?

a. AD shift right, E3 intersect with AD, SRAS2, and LRAS b. AD shift left. E3 intersect with AD and SRAS2 c. Expansionary fiscal policy can help bring output back to potential but makes the problem of inflation worse. Contractionary fiscal policy keeps prices under control but increases the recessionary gap imposed by stagflation.

Please select the type of shock that would produce the indicated shift. a. A leftward shift in the AD curve b. A leftward shift in the SRAS curve c. A rightward shift in the SRAS curve d. A positive shift that leads to a higher aggregate price level. e. A rightward shift in the AD curve f. A negative shift that leads to a lower aggregate price level g. Stagflation h. A negative shift that leads to a higher aggregate price level i. A positive shift that leads to a lower aggregate price level

a. Negative demand shock b. Negative supply shock c. Positive supply shock d. Positive demand shock e. Positive demand shock f. Negative demand shock g. Negative supply shock h. Negative supply shock i. Positive supply shock

Suppose that the economy of Monaco is represented by the aggregate demand (AD), short-run aggregate supply (SRAS), and long-run aggregate supply (LRAS) curves in the accompanying graph. a. Based on the graph, Monaco is b. Which of the following policies eliminate this phenomenon? c Suppose that the government implements the policy proposed in part b. Shift the aggregate demand curve on the graph accordingly.

a. experiencing an inflationary gap. b. An increase in taxes c. AD moved left

The accompanying graph represents the Keynesian cross for a country, where the planned aggregate spending line (Planned AE) is graphed against a 45° line. Suppose that there is an autonomous decrease in aggregate spending of $40 billion in this country. a. Show this change on the graph (you can drag and shift the whole line or either of the endpoints) and answer the following two questions. b. What is the initial unplanned inventory investment? If the number is negative, be sure to include a negative sign. c. After firms adjust their production, what is the total change in real GDP? If the number is negative, be sure to include a negative sign.

a.) graph endpoint: (0, 20) (200, 120) b.) 40 billion dollars c.) -80 billion dollars

Increasing funding for space exploration will shift the _____ curve to the _____.

aggregate demand; right

The aggregate supply curve shows the relationship between the _____ and the quantity of aggregate output supplied.

aggregate price level

(Figure: The Aggregate Consumption Function and Planned Aggregate Spending) Use Figure: The Aggregate Consumption Function and Planned Aggregate Spending. If aggregate wealth increases, the:

aggregate spending line will shift up.

Which fiscal policy would make a budget surplus smaller or a budget deficit larger?

an increase in government purchases of goods and services

The government is concerned about an inflationary gap. Shift the AD curve to provide a graphical representation of an inflationary gap and move the point, ESR, to the short-run equilibrium associated with the inflationary gap. Which of the following policies will help to eliminate the inflationary gap?

an increase in taxes graph: AD moved right, E intersects wish SRAS and AD

Social Security and Medicare:

are implicit liabilities.

An increase in the wealth of households, other things equal, will _____ the aggregate consumption function.

cause an upward shift of

A government might want to decrease aggregate demand to:

close an inflationary gap.

Changes in short-run aggregate supply can be caused by changes in:

commodity prices.

Automatic stabilizers are government spending and taxation changes that cause fiscal policy to be _____ when the economy expands.

contractionary

(Figure: Short-Run Equilibrium) Use Figure: Short-Run Equilibrium. If the economy is in equilibrium at Y1 and P1, the government should use _____ fiscal policy to shift the aggregate demand curve to the _____.

contractionary; left

Your study partner argues that the distinction between the government's budget deficit and debt is similar to the distinction between consumer savings and wealth. He also argues that if you have large budget deficits, you must have a large debt. In what ways is your study partner correct and in what ways is he incorrect? Your partner is _____ about the similarity between the deficit-debt distinction and the savings-wealth distinction. He is ____ that large budget deficits imply large levels of debt.

correct incorrect

In an economy with no taxes or imports, if the marginal propensity to consume increases, the marginal propensity to save will _____.

decrease

(Figure: Fiscal Policy Options) Use Figure: Fiscal Policy Options. If the aggregate demand curve is ADʺ, the most appropriate discretionary fiscal policy is to _____ government transfer payments and _____ income tax rates.

decrease; increase

Contractionary fiscal policy includes:

decreasing government spending.

The graph models an economy in equilibrium with a real GDP of $180 billion$180 billion. Suppose that consumers' expectations about future incomes change, causing unplanned inventory investment to increase by $30 billion$30 billion. Shift the planned aggregate expenditure (AE) line to show the effect of this change. This change will cause the equilibrium level of real GDP to By how much will GDP change once the new equilibrium is reached? If GDP will decrease, be sure to include a negative sign.

graph endpoints: (0,60) (300, 210) Decrease GDP change: $ -60 billion

If the multiplier is 4, and autonomous government spending decreases by $100 billion, real GDP will:

increase by $400 billion.

The short-run aggregate supply curve would NOT shift to the left as a result of a(n):

increase in interest rates.

(Figure: Shift of the Aggregate Demand Curve) Use Figure: Shift of the Aggregate Demand Curve. A movement from point A on AD1 to point C on AD2 may result from a(n):

increase in the total quantity of consumer goods and services demanded.

(Figure: Policy Alternatives) Use Figure: Policy Alternatives. If the economy is in equilibrium at Y1 in panel (a), and the government decides to intervene, it will MOST likely:

increase its spending.

(Figure: Policy Alternatives) Use Figure: Policy Alternatives. In panel (b), the economy is initially in short-run equilibrium at a real GDP of Y1 and price level of P2. If the government decides to intervene, it will MOST likely:

increase its spending.

Suppose an economy's aggregate output is below potential output. If the government wishes to use fiscal policy to bring the economy back to potential output, it will:

increase its spending.

If real GDP is less than aggregate spending, then inventories will _____, and firms will _____.

increase; cut back on future production

In the income-expenditure model, if the price level ____, the wealth and interest rate effects of a change in the price level will ____ planned expenditures.

increases; decrease

If the economy is in a recessionary gap, actual output will be _____ potential output.

less than

If the marginal propensity to consume is 0.75, the multiplier for taxes and transfer payments is:

less than 4.

Assume that marginal propensity to consume is 0.8, and potential output is $800 billion. The tax multiplier is:

less than 5.

A bank run occurs when:

many bank customers try to withdraw their funds at one time.

(Figure: AD-AS Model I) Use Figure: AD-AS Model I. If the economy is at point X, there is a(n) _____ gap with _____ unemployment.

recessionary; high

If government increases income tax rates, the aggregate demand curve is likely to:

shift to the left.

The national debt _____ when the federal government incurs a _____.

stays the same; stays the same

The multiplier (expenditure multiplier) is the ratio between which two measures?

total change in real GDP due to an autonomous change in aggregate spending AND the size of the autonomous change in aggregate spending

You just deposited $4,000 in cash into a checking account at the local bank. Assume that banks lend out all excess reserves and there are no leaks in the banking system. That is, all money lent by banks gets deposited in the banking system. Round your answers to the nearest dollar. If the reserve requirement is 14%, how much will your deposit increase the total value of checkable bank deposits? If the reserve requirement is 5%, how much will your deposit increase the total value of checkable deposits? Decreasing the reserve requirement _______ the money supply.

total increase in checkable deposits=deposit/𝑟𝑟 $ 28571 (40000/.14=28571) $8000 ($40000/.05=80000) increases

Answer the questions about Keynes and his history. John Maynard Keynes famously said: "In the long run, Keynes was an economist during the Great Depression. During the Great Depression there was

we are all dead." high unemployment and high deflation.

Identify the best definition of money.

whatever serves society in three functions: medium of exchange, store of value, and unit of account

Match the statements with the appropriate definition. Not all statements will be used. Money is best defined as Barter is best defined as A double coincidence of wants is

whatever serves society in three functions: medium of exchange, store of value, and unit of account. literally trading one good for another without using money. a situation where two individuals each want some or service that the other can provide.

(Figure: Inflationary and Recessionary Gaps) Use Figure: Inflationary and Recessionary Gaps. The level of income associated with Y1 in panel (b):

would indicate an inflationary gap.

Troll Island is a small island nation that recently experienced an autonomous change in aggregate expenditures (AE). AE increased by 44 billion, and the marginal propensity to consume on Troll Island is equal to 0.70.7. What is the change in Troll Island's real GDP after the increase in AE? Enter your answer in billions of dollars, rounded to one place after the decimal. For example, an answer of $2,500,000 should be entered as 2.5.

$ 13.3 billion

(Figure: Aggregate Demand) Use Figure: Aggregate Demand. The quantity of output demanded at a price level of 120 is:

$10 trillion.

(Table: Assets and Liabilities) Use Table: Assets and Liabilities. If the reserve ratio is 20%, deposits are: Table: Assets and Liabilities Assets Liabilities Reserves $20,000 Deposits Loans

$100,000.

(Figure: Aggregate Demand) Use Figure: Aggregate Demand. The quantity of output demanded if the price level is 100 is:

$12 trillion.

(Scenario: First National Bank) First National Bank has $80 million in checkable deposits, $15 million in deposits with the Federal Reserve, $5 million cash in the bank vault, and $5 million in government bonds. If the minimum reserve ratio is 20%, how much is the bank required to keep in reserves?

$16 million

Real GDP is $3,000, autonomous consumption is $500, and planned investment spending is $200. The marginal propensity to consume is 0.8. What is planned aggregate spending?

$2,900.

Suppose that a bank does NOT hold excess reserves and that the reserve ratio is 20%. If Shanice deposits $1,000 of cash in her checking account, and the bank lends $600 to Freda, the bank can lend an additional:

$200.

(Figure: Aggregate Expenditures I) Use Figure: Aggregate Expenditures I. Equilibrium real GDP is:

$500 billion.

(Figure: Shifts of the AD-AS Curves) Use Figure: Shifts of the AD-AS Curves. A short run increase in net exports is illustrated by panel:

(a).

In an economy with no taxes and no imports, disposable income increases from $1,000 to $2,000. If consumption increases from $800 to $_____, the marginal propensity to save is 0.3.

1,500

M1 is the narrowest definition of the money supply. It includes currency in circulation, checking account deposits and travelers checks. The statements refer to factors that can affect the money multiplier. Label each statement as true or false. 1. The total change in the M1 brought about by the money multiplier is affected by the amount of deposit made by households and business. 2. Banks must lend out all their excess reserves in order to change the M1 money supply 3. The Federal Reserve has very little effect on the money multiplier. 4. The state of the economy can affect the amount of excess reserves that banks keep on reserve, thereby affecting the impact of the money multiplier.

1. T 2. f 3. f 4. t

For each of the scenarios, please decide whether there will be an increase, decrease, or no change in aggregate demand. 1. The United States government decides to increase the federal tax rate by 4% for all earners. 2. The newest release of the Consumer Confidence Index shows a steady increase in consumer confidence about the economy. 3. A manufacturing boom during the late 1990s has created an oversupply of tractors, a necessary implement in agricultural production. 4. The Federal Reserve, the agency charged with regulating banking and monetary policy in the United States, decides to increase the amount of money available in the economy.

1. aggregate demand decreases 2. aggregate demand increases 3. aggregate demand decreases 4. aggregate demand increases

For each of the scenarios, please decide whether there will be an increase or decrease in short-run aggregate supply or if there will be no change. 1. Changes in the healthcare market cause employers to pay significantly more for health insurance they provide employees. 2. The price of lumber, a commodity, rises drastically due to the effect of heavy winter weather in the American Northwest, where much of the world's lumber is grown. 3. The production of a new type of blade for their combine harvesters, a tractor used to harvest crops, has allowed wheat farmers, like Herbert, to increase productivity by 40%.

1. short-run aggregate supply decreases 2. short-run aggregate supply decreases 3. short-run aggregate supply increases

(Figure: Aggregate Expenditures Curve II) Use Figure: Aggregate Expenditures Curve II. The slope of the aggregate spending line is:

45 degrees.

Assume that the marginal propensity to consume is 0.8 and potential output is $800 billion. The government spending multiplier is:

5.

(Figure: AD-AS Model II) Use Figure: AD-AS Model II. When consumers and firms become more optimistic, in the short run, the _____ curve will shift to the _____.

AD; right

In the financial crisis of 2008, which of the following were rescued by the government?

AIG and Bear Stearns

Income and Expenditure — End of Chapter Problem The Bureau of Economic Analysis reported that, in real terms, overall consumer spending increased by $335.5 billion in 2019. a. If the marginal propensity to consume is 0.50, by how much will real GDP change in response? Enter your answer in billions of dollars. b. If there are no changes in autonomous spending other than the increase in consumer spending described in part a, and unplanned inventory investment, 𝐼𝑢𝑛𝑝𝑙𝑎𝑛𝑛𝑒𝑑, decreases by $100 billion, what is the change in real GDP? Enter your answer in billions of dollars. c. GDP at the end of 2019 was $18,638.2 billion. If GDP were to increase by the amount calculated in part b, what would be the percentage increase in GDP? Round your answer to the nearest hundredth of a percent.

Change in GDP: $ 671 billion (1/1−0.50×$335.5 billion = $671 billion) Change in GDP: $ 471 billion (1/1−0.50×($335.5 billion−$100 billion)= $471 billion) Percentage change in GDP: 2.53% ($471 billion/$18,638.2 billion×100=2.53%)

The accompanying graphs illustrate an initial equilibrium for the economy. Suppose that a snowstorm destroys a large number of corn crops. Use the graphs to show the new positions of aggregate demand (AD), short-run aggregate supply (SRAS), and long-run aggregate supply (LRAS) in both the short-run and the long-run, as well as the short-run (ESR) and long-run (ELR) equilibria resulting from this change. Then answer what happens to the price level and GDP. In the short run, the price level __________ and real GDP ________. In the long run, the price level __________ and real GDP ___________.

Economy in the Short Run: SRAS moved left; E intersects with SRAS and AD (increases; decreases) Economy in the Long Run: stays the same (stays the same; stays the same)

Which of the statements best describes the paradox of thrift?

Households increase savings during recessions, which causes consumption to fall, aggregate expenditures to fall, and may possibly lead to or make worse a recession.

Classify each scenario based on whether it increases or decreases aggregate demand (AD).

Increase Aggregate Demand a billion dollars falls from the sky interest rate decreases the government buys airplanes income taxes fall interest rates fall for businesses only Decrease Aggregate Demand consumers expect income taxes to rise in the future businesses believe that consumer demand will fall in the future the relative price of foreign goods decreases

Income and Expenditure — End of Chapter Problem How will planned investment spending change as the following events occur? The interest rate falls as a result of Federal Reserve policy. The U.S. Environmental Protection Agency (EPA) decrees that corporations must upgrade or replace their machinery in order to reduce their emissions of sulfur dioxide. Baby boomers begin to retire in large numbers and reduce their savings, resulting in higher interest rates. Match each event to its effect on planned investment spending.

Increase planned investment spending: Federal Reserve policy lowers interest rates The EPA requires sulfur dioxide emissions reductions Decrease planned investment spending Baby boomers' retirement increases interest rates

Income and consumption changes for five people are shown in the table. Given this information, rank the marginal propensities to consume (MPC) for the five people from largest to smallest. Name Income Change Consumption Change Arnold +$20,000 +12,000 Bert +$10,000 +$3,200 Colin +$4,000 +$3,200 Daron -$10,000 -$7,000 Eli -$20,000 -$8,000

Largest MPC Colin (+$3,200/+$4,000=0.8) Daron (−$7,000/−$10,000=0.7) Arnold (+$12,000/+$20,000= 0.6) Eli (−$8,000/−$20,000=0.4) Bert (+$3,200/+$10,000=0.32) Smallest MPC

Deriving the Multiplier Algebraically — End of Appendix Problem Complete the accompanying table by calculating the value of the multiplier and identifying the change in 𝑌∗Y∗ due to the change in autonomous spending. Enter 𝑌∗Y∗ in millions of dollars. 𝑀𝑃𝐶 Value of multiplier Change in spending Change in 𝑌∗ 0.5 ? ΔC = + $50 million ? 0.6 ? ΔI = - $10 million ? 0.75 ? ΔC = - $25 million ? 0.8 ? ΔI = + $20 million ? 0.9 ? ΔC = - $2.5 million ? How does the value of the multiplier change with the marginal propensity to consume?

MPC = 0.5; consumption increases by $50 million. Multiplier = 2 Change in 𝑌∗= $ 100 million MPC = 0.6; investment decreases by $10 million. Multiplier = 2.5 Change in 𝑌∗= $ -25 million MPC = 0.75; consumption decreases by $25 milllion. Multiplier = 4 Change in 𝑌∗= $ -100 million MPC = 0.8; investment increases by $20 million. Multiplier = 5 Change in 𝑌∗= $ 100 million MPC = 0.9; consumption decreases by $2.5 million. Multiplier = 10 Change in 𝑌∗= $ -25 million As the MPC increases, the multiplier increases.

How, if at all, did these events affect the long‑run aggregate supply (LRAS) curve? Each phrase should be placed under the appropriate heading.

Shifted the LRAS curve to the left a tsunami destroying much of the existing stock of capital in Japan the 1970s oil crisis significant and sustained increases in income tax rates Shifted the LRAS curve to the right the Internet revolution of the 1990s James Watt's invention of the steam engine in 1775 Did not shift LRAS a central bank increasing the amount of money in circulation

(Figure: AD-AS) Use Figure: AD-AS. Suppose the economy is in an inflationary gap, so that SRAS1 intersects AD2. The size of the inflationary gap is equal to:

Y1 - YP.

(Figure: Inflationary and Recessionary Gaps) Use Figure: Inflationary and Recessionary Gaps. Which equation measures a recessionary gap?

Y2 - Y1

Commodity money is:

a good used as a medium of exchange that has other uses.

The wealth effect suggests:

a negative relationship between the price level and consumer spending.

(Figure: Policy Alternatives) Use Figure: Policy Alternatives. In panel (a), if the economy is at an aggregate output of Y1 and a price level of P2, the economy is in:

a recessionary gap.

Fiscal Policy — End of Chapter Problem Unlike households, governments are often able to sustain large debts. For example, in 2019, the U.S. government's total debt reached $21.2 trillion, approximately equal to 105.3% of GDP. At the time, according to the U.S. Treasury, the average interest rate paid by the government on its debt was 1.3%. However, running budget deficits becomes hard when very large debts are outstanding. a. Calculate the dollar cost of the annual interest on the government's total debt, assuming the interest rate and debt figures previously cited. Enter your answer in billions of dollars, and round to the nearest tenth. b. If the government operates on a balanced budget before interest payments are taken into account, at what rate must GDP grow for the debt-GDP ratio to remain unchanged? Enter your answer as a percentage and round to the nearest tenth of a percent. c. Calculate the total increase in national debt if the government incurs a deficit of $600 billion in 2020. Enter your answer in billions of dollars and round to the nearest tenth. d. At what rate would GDP have to grow in order for the debt-GDP ratio to remain unchanged when the deficit in 2020 is $600 billion? Enter your answer as a percentage and round your answer to the nearest hundredth of a percent. e. Why is the debt-GDP ratio the preferred measure of a country's debt rather than the dollar value of the debt? Why is it important for a country to keep its debt-GDP ratio under control?

a. $275.6 b. 1.3 c. $875.6 d. 4.13% e. The size of an economy, measured by its GDP, determines a government's ability to repay debt through taxes. The debt-GDP ratio is a more accurate reflection of how burdened a country is by debt than the dollar value of the debt. A government should keep the debt-GDP ratio under control to keep itself from being overburdened by debt.

The accompanying diagram shows the current macroeconomic situation of the economy of Albernia. You have been hired as an economic consultant to help the economy move to potential output, which is $200 billion. a. Is Albernia facing a recessionary or inflationary gap? b. Which type of fiscal policy would move the economy of Albernia to potential output? What are some examples of such policies? Check all that apply. c. In the accompanying diagram, shift the AD, LRAS, and/or SRAS curves and move the equilibrium point to its new position to illustrate the macroeconomic situation of Albernia after a fiscal policy has been successfully implemented.

a. Recessionary gap b. Expansionary Increasing government transfers/ Increasing government purchases of goods c. AD move up

Fiscal Policy — End of Chapter Problem An economy is in long-run macroeconomic equilibrium when each of the following aggregate demand shocks occurs. Determine if each scenario would lead to an inflationary or recessionary gap. a. A stock market boom increases the value of stocks held by households, resulting in b. Firms come to believe that a recession is likely in the near future, leading to c. Anticipating the possibility of war, the government increases its purchases of military equipment. This added spending resulting d. Interest rates increase, bringing about spending changes that result in If the economy faces an inflationary gap, then policy makers could use __________ fiscal policies to move the economy back to potential output. This will shift the aggregate demand curve to the __________. If the economy faces a recessionary gap, then policy makers could use ____________ fiscal policies to move the economy back to potential output. This will shift the aggregate demand curve to the _________.

a. an inflationary gap b. a recessionary gap c. an inflationary gap d. a recessionary gap contractionary; left expansionary; right

Categorize the scenarios as either a discretionary act or the result of automatic stabilizers. a. A recession increases the number of recipients of unemployment benefits. b. A law is enacted that increases government spending on health‑care programs. c. Legislators increase the generosity of unemployment benefits. d. Economic growth increases personal and corporate income, increasing tax payments.

a. automatic stabilizers b. discretionary spending c. discretionary spending d. automatic stabilizers

Identify how each of the scenarios affects short‑run aggregate supply. a. The U.S. government increases the minimum wage. b. Widespread adoption of the Internet by businesses increases productivity and efficiency. c. The government decreases the payroll tax paid by employers. d. The U.S. government decreases the personal income tax rate paid by households.

a. decrease b. increase c. increase d. no change

Income and Expenditure — End of Chapter Problem In an economy with no government and no foreign sector, autonomous consumer spending is $250 billion, planned investment spending is $350 billion, and the marginal propensity to consume is 2323. a. Using the accompanying diagram, select the endpoints of the aggregate expenditure function and the endpoints of the consumption function to graph the corresponding lines. Also, move the point for real GDP, Y*, to indicate income-expenditure equilibrium. b. Unplanned inventory investment, when real GDP equals $600 billion, is $ c. Y*, the income-expenditure equilibrium GDP, is $ d. The value of the multiplier is e. If planned investment spending rises to $450 billion, the new Y* is $

a. graph endpoint: AE [(0,600) (2700, 400)] CF [(0, 0) (3000, 2100)] y* (1800, 1800) b. -400 c. 1800 d. 3 e. 2100

Fiscal Policy — End of Chapter Problem The accompanying diagram shows the current macroeconomic situation of the economy of Brittania, with real GDP of $50 billion. You have been hired as an economic consultant to help the economy move to potential output, which is $40 billion. a. Is Brittania facing a recessionary or inflationary gap? b. Which type of fiscal policy—expansionary or contractionary—would move the economy of Brittania to potential output? c. Illustrate the macroeconomic situation in Albernia on the accompanying diagram after the successful fiscal policy has been implemented.

a. inflationary gap b. Contractionary Increasing taxes c. AD moved left

Income and Expenditure - End of Chapter Problem Economists observed the only five residents of a very small economy and estimated each one's consumer spending at various levels of current disposable income. The accompanying table shows each resident's consumer spending at three income levels. Individual current disposable income Individual consumer spending by $0 $20,000 $40,0000 Andre 1000 15000 29000 Barbara 2500 12500 22500 Casey 2000 20000 38000 Declan 5000 17000 29000 Elena 4000 19000 34000 a. What is the marginal propensity to consume for each resident? Enter your answers in decimal form. What is each resident's consumption function? Assume each consumption function is linear, and let y denote a consumer's disposable income. b. What is the marginal propensity to consume for the economy? Enter your answer in decimal form. What is the consumption function for the economy?

a.) Andre MPC: 0.70 ($29,000−$15,000/$40,000−$20,000=0.70) c= 1000+0.70*y (a= $0 column) Barbara MPC: 0.50 c=2500+0.50*y Casey MPC: 0.90 c=2000+0.90*y Declan MPC: 0.60 c=5000+0.60*y Elena MPC: 0.75 c=4000+0.75*y b.) Economy's MPC: 0.69 c= 14500 + 0.69 *y (When each resident earns $0 in disposable income, aggregate consumer spending is $14,500. When each resident earns $20,000 in disposable income, aggregate disposable income is $100,000, and aggregate consumer spending is $83,500. When each resident earns $40,000 in disposable income, aggregate disposable income is $200,000, and aggregate consumer spending is $152,500. Aggregate autonomous consumer spending is $14,500, and the marginal propensity to consume is 0.69=$83,500−$14,500/$100,000−$0)

Income and Expenditure — End of Chapter Problem Assuming that the aggregate price level is constant, the interest rate is fixed, and there are no taxes and no foreign trade, what will be the change in GDP if the following events occur? Please answer in billions of dollars. a. There is an autonomous increase in consumer spending of $25 billion, and the marginal propensity to consume is 2/3. b. Firms reduce investment spending by $40 billion, and the marginal propensity to consume is 0.8. c. The government increases its purchases of military equipment by $60 billion, and the marginal propensity to consume is 0.6.

a.) Change in GDP: $ 75 billion b.) Change in GDP: $ -200 billion c.) Change in GDP: $ 150 billion

Income and Expenditure — End of Chapter Problem During the early 2000s, the Case-Shiller U.S. Home Price Index, a measure of average home prices, rose continuously until it peaked in March 2006. From March 2006 to May 2009, the index lost 32% of its value. Meanwhile, the stock market experienced similar ups and downs. From March 2003 to October 2007, the Standard and Poor's 500 (S&P 500) stock index, a broad measure of stock market prices, almost doubled, from 800.73 to a high of 1,565.15. From that time until March 2009, the index fell by almost 60%, to a low of 676.53. How do you think the movements in home prices both influenced the growth in real GDP during the first half of the decade and added to concerns about maintaining consumer spending after the collapse in the housing market that began in 2006? a. The increase in home prices directly increased consumers' _________, increasing consumer spending and thus real GDP. The fall in home prices that began in March 2006 had the opposite effect. b. To what extent did the movements in the stock market hurt or help consumer spending? The increase in stock prices directly increased consumers' ___________, increasing consumer spending. The decrease in stock prices that began in October 2007 had the opposite effect.

a.) wealth held in real estate b.) wealth held in stocks

(Figure: Aggregate Supply) Use Figure: Aggregate Supply. If the economy is at point E:

actual output is greater than potential output.

Fiscal Policy — End of Chapter Problem In the following case, either a recessionary or inflationary gap exists. Assume that the aggregate supply curve is horizontal so that the change in real GDP arising from a shift of the aggregate demand curve equals the size of the shift of the curve. Calculate the magnitude of both the change in government purchases of goods and services and the change in government transfers necessary to close the gap. Real GDP equals $180 billion, potential output equals $100 billion, and the marginal propensity to consume is 0.8. The economy faces ______ gap. To close the gap, government spending and/or transfers would need to ______. Spending would need to change by $ _____ billion (in absolute value) to close the gap. Transfers would need to change by $ _____ billion (in absolute value) to close the gap.

an inflationary spending 16 transfer 20

Fiscal Policy — End of Chapter Problem In the following case, either a recessionary or inflationary gap exists. Assume that the aggregate supply curve is horizontal so that the change in real GDP arising from a shift of the aggregate demand curve equals the size of the shift of the curve. Calculate the magnitude of both the change in government purchases of goods and services and the change in government transfers necessary to close the gap. Real GDP equals $250 billion, potential output equals $200 billion, and the marginal propensity to consume is 0.5. The economy faces _______ gap. To close the gap, government spending and/or transfers would need to ______. Spending would need to change by $ ____ billion (in absolute value) to close the gap. Transfers would need to change by $ _____ billion (in absolute value) to close the gap.

an inflationary; decrease Spending 25 transfer 50

Interest rates were low in the United States in 2003 because of:

capital inflows and monetary policy.

If the government is required to balance the budget and the economy falls into a recession, which of the actions is a feasible policy response? What is a likely consequence of this policy?

cut spending equal to the reduction in tax revenue The negative consequences of the recession are magnified.

(Figure: Consumption Functions) Use Figure: Consumption Functions. An economy's consumption function would shift from curve C to curve C'' when there is a(n):

decrease in wealth.

An increase in interest rates on business loans will _____ investment spending.

decrease planned

If policy makers want to decrease real GDP by $100 billion, and the marginal propensity to consume is 0.6, they should _____ government purchases of goods and services by _____.

decrease; $40 billion

Scenario: Money Supply Changes II Lucia withdraws $8,000 from her checking account to pay tuition this semester. Assume that the reserve requirement is 20% and that banks do not hold excess reserves. As a result of the withdrawal, loans _____ by _____.

decrease; $6,400

Suppose the island of Catsylvania experiences a recession. As a result, consumers reduce spending on Kitty Chow and planned aggregate expenditures fall short of real GDP. As a result, unplanned inventories at Kitty Chow firms will Thankfully, the recession is very short and consumer spending on Kitty Chow increases to prerecession levels. What is most likely to occur first at Kitty Chow firms during this period of recovery?

increase Firms will sell off excess inventories before returning to increased production levels.

As the marginal propensity to consume (MPC) increases, the multiplier As the marginal propensity to save (MPS) increases, the multiplier If the marginal propensity to consume is 0.400.40, what is the multiplier, assuming there are no taxes or imports? Round to the tenths place. Given the multiplier that you calculated, by how much will gross domestic product (GDP) increase when there is a $1,000 increase in government spending? Give your answer to the nearest whole number.

increases. decreases. 1.7 $1700

The cyclically balanced budget deficit fluctuates _____ the actual budget deficit.

less than

The federal government's LARGEST source of revenue is:

personal income and corporate profit taxes.

(Figure: Aggregate Expenditures and Real GDP) Use Figure: Aggregate Expenditures and Real GDP. At a real GDP of $9,000 billion:

planned investment is less than actual investment.

(Figure: Fiscal Policy Choices) Use Figure: Fiscal Policy Choices. If the government uses discretionary fiscal policy in the economy depicted in panel (b) when real GDP is Y1, government spending is likely to be _____, and taxes are likely to be _____.

reduced; increased

The monetary base is the sum of:

reserves held by banks and currency in circulation.

Decisions about monetary policy are made by:

the Federal Open Market Committee.

(Figure: An Increase in Aggregate Demand) Use Figure: An Increase in Aggregate Demand. At the Y2 level of real GDP:

there is an inflationary gap equal to the difference between Y2 and YP.

Whenever planned aggregate spending exceeds real GDP, unplanned inventory investment is:

unpredictable.

Assume that the required reserve ratio is set at 0.06250.0625 . What is the value of the money (deposit) multiplier? Suppose that a bank holds no excess reserves and receives a deposit from a customer of $350350. How does this impact the money supply? Which statement is a consequence of fractional reserve banking?

value of money multiplier: 16 (money multiplier=1/0.0625=16) increase in money supply: $ 5600 ($5600=16×$350) Fractional reserve banking implies that private banks have a role in making changes to the money supply.