Econ 2 Ch 10
For the GDP to change when the AS curve is horizontal, means it must change through:
Increases or decreases in aggregate demand
Considering that Aggregate Expenditure = C + I + G + (X - M), which function is drawn as a horizontal line?
Investment
To find macro equilibrium in a table, the numbers for ________ and ________ should equal each other.
aggregate expenditure; GDP/national income
The ________ is a graphical relationship between income and consumer spending.
consumption function
An decrease in the Marginal Propensity to Consume (MPC) ________ the consumption function
flattens
An decrease in the Marginal Propensity to Consume (MPC) ________ the consumption function.
flattens
Marginal Propensity to Save:
fraction of any change in income which is saved; algebraically MPS = ΔS /ΔY
marginal propensity to save:
fraction of any change in income which is saved; algebraically MPS = ΔS/ΔY
marginal propensity to consume:
fraction of any change in income which is spent; algebraically MPC = ΔC/ΔY
Marginal Propensity to Consume:
fraction of any change in income which is spent; algebraically MPC =ΔC /ΔY
Marginal Propensity to Import:
fraction of any change in income which is spent; algebraically MPI =ΔM /ΔY
Consumption Function:
graphical relationship between national income and consumption expenditure; algebraically: C = a + MPC*Y, where a is autonomous consumption (the amount of consumption expenditure when Y = 0), MPC is the marginal propensity to consume, and Y is national income
In a Keynesian cross diagram, what name is given to the distance between an output level that is above potential GDP?
inflationary gap
The quantity of output that the economy can produce when it is at full employment of its labor and physical capital is the definition for
potential real GDP.
The pure Keynesian AD-AS model assumes that for any level of GDP below potential, any change in AD affects real GDP, but NOT the ________.
price level
In a Keynesian cross diagram, what name is given to the distance between an output level that is below potential GDP and potential GDP?
recessionary gap
In a Keynesian cross diagram, what name is given to the distance between an output level that is below potential GDP?
recessionary gap
An increase in taxes will ________ consumption spending as it relates to the function of national income.
reduce When taxes are included, the marginal propensity to consume is reduced by the amount of the tax rate, so each additional dollar of income results in a smaller increase in consumption than before taxes. For this reason, the consumption function, with taxes included, is flatter than the consumption function without taxes.
Say that an economy is defined by the following algebraic equation: C = 322 + 0.7 (Yd). What does the algebraic equation represent?
the consumption function
Graphically, the aggregate expenditure function is formed by adding together (or stacking on top of each other) ________.
the consumption function (after taxes), the investment function, the government spending function, and the net export function
Aggregate Expenditure (AE) as the sum of expenditures on all final goods and services at a given price level so AE = C + I + G + NX or (X-M). The upward slope of AE will be determined by each of these factors except ________.
the marginal propensity to export The upward slope of the aggregate expenditure function will be determined by the marginal propensity to consume, the tax rate, and the marginal propensity to import. For example, A lower marginal propensity to consume, a higher tax rate, and a higher marginal propensity to import will all make the slope of the aggregate expenditure function flatter—because out of any extra income, more is going to savings or taxes or imports and less to spending on domestic goods and services.
For the slope (steepness of the line) of the consumption function to change, ________ would have to increase or decrease.
the marginal propensity to consume A change in the marginal propensity to consume will change the slope of the consumption function. An increase in the MPC steepens the consumption function; a decrease in the MPC flattens it.
Of these statements about the potential GDP line, which is incorrect?
the potential GDP line makes the assumption that it is at less than full employment of its physical capital and labor. (CHeck)
Potential real GDP is defined as ________.
the quantity of output that the economy can produce when it is at full employment of its labor and physical capital.
If a person has zero income, consumption still exists because ________.
there are basic needs people still have to meet
Assume the following macroeconomic variable (in $ billion) for an economy: Y = national income = Aggregate Expenditures Aggregate Expenditures = Consumption + Investment + Government Spending + Net Export Assuming that the full employment level in $5,500 billion, determine the change in government spending needed to reach full employment. (Hint: calculate the current GDP, then calculate aggregate expenditures using national income of $5,500 and find the difference)
$220 The current GDP is $5000 and aggregate expenditures with a national income for $5,500 would be $5,280, therefore the level of expenditures needs to increase by $280.
Assume the following macroeconomic variable ( in $ billion) for an economy: Y = national income = Aggregate Expenditures Aggregate Expenditures = Consumption + Investment + Government Spending + Net Export Assuming that the full employment level in $6,000 billion, determine the change in government spending needed to reach full employment. (Hint: calculate the current GDP, then calculate aggregate expenditures using national income of $6,000 and find the difference)
$40
Consider the following consumption function: C = 70 + 0.75*Y What is the MPC?
0.75
Suppose spending increases by $10 million resulting in a $100 million increase in real GDP. What would be the multiplier?
10 So the calculation is $100 million/$10 million = 10.
Suppose the MPC is 60%, what is the spending multiplier?
2.5 Remember the multiplier = 1/(1-MPC), so if MPC is 60% then 1/(1-0.6) = 2.5.
Assume the following macroeconomic variable ( in $ billion) for an economy: Y = national income = Aggregate Expenditures Aggregate Expenditures = Consumption + Investment + Government Spending + Net Export Assuming that the full employment level in $6,000 billion, determine the change in government spending needed to reach full employment. (Hint: calculate the current GDP, then calculate aggregate expenditures using national income of $6,000 and find the difference)
440
Assume the following macroeconomic variable ( in $ billion) for an economy: Y = national income = Aggregate Expenditures Aggregate Expenditures = Consumption + Investment + Government Spending + Net Export Assuming that the full employment level in $6,000 billion, determine the change in government spending needed to reach full employment. (Hint: calculate the current GDP, then calculate aggregate expenditures using national income of $6,000 and find the difference)
440
Considering the Keynesian Cross Diagram, the income=expenditure line is also called the ________.
45-degree line
Macro equilibrium in the income-expenditure model occurs where aggregate expenditure is equal to national income; this occurs where the aggregate expenditure schedule crosses the ________.
45-degree line
What is the income=expenditure line called in the Keynesian Cross Diagram?
45-degree line
Consider the following consumption function: C = 70 + 0.75*Y What is the level of autonomous consumption?
70
The marginal propensity to consume (MPC) will always be ________.
< 1 Since the only options are to consume or save income, it must always hold true that: MPC + MPS = 1. For example, if the marginal propensity to consume out of the marginal amount of income earned is 0.9, then the marginal propensity to save is 0.1.
The marginal propensity to save (MPS) will always be ________.
< 1 Since the only options are to consume or save income, it must always hold true that: MPC + MPS = 1. For example, if the marginal propensity to consume out of the marginal amount of income earned is 0.9, then the marginal propensity to save is 0.1.
According to the graph, which of the following statements is accurate?
A new equilibrium is created with an increase in AE0 to AE1.
Aggregate Expenditure Schedule
aggregate expenditure function expressed as a table
When looking to discover what the increase in expenditure is, the graph identifies it as the vertical increase from ________.
AE0 to AE1
Which of the following is true?
AE=GDP=Y= C + I + G + (X - M)
Which of these statements is correct regarding what a stock market crash would typically do to actual GDP versus potential GDP?
Actual GDP would fall below potential GDP. This is because wealth would decrease causing a decline in consumption spending.
According to the graph, which is a true statement?
An increase in AE0 to AE1 creates a new equilibrium..
According to the graph, which is a true statement?
An increase in AE0 to AE11 creates a new equilibrium.
What is the best explanation for the relatively horizontal area of the short run aggregate supply curve?
An increase in aggregate demand when the economy is operating below potential output causes real output to grow, with little or no effect on the price level.
When looking at the graph of an income-expenditure model where would the macro equilibrium be found?
At the level of GDP where aggregate expenditure equals national income.
Where is the macro equilibrium found in the income-expenditure model graphically?
At the level of GDP where national income equals aggregate expenditure.
Aggregate Expenditure Schedule:
aggregate expenditure function expressed as a table
Which of the following is true about export and imports as function of national income?
Both are horizontal lines with imports being negative as it relates to real GDP.
When potential GDP is reached, aggregate supply becomes vertical for ________.
Both the income-expenditure model and the traditional AD-AS model
Using Figure 1, how would the Aggregate Expenditure Schedule be defined from a Keynesian perspective?
C + I + G + (X - M) The Aggregate Expenditure Function shows the relationship between national income and aggregate expenditure therefore the Keynesian Schedule would be Aggregate Consumption + Planned Investment + Government Expenditure + Net Exports (Exports − Imports).
Aggregate Expenditure equals
C + I + G + (X-M).
consumption function formula
C = A + MPC x YD
Given this data the consumption function can be written as
C = a + MPC*Y MPC = Change in C/ Change in Y 195/300 =.65 740=a +MPC*1000 740=a +.65*1000 740=a +650 a=740-650=90 C = 90 + 0.65Y
Given this data, what is the level of autonomous consumption?
C = a + MPC*Y, equation I; 695= a+ MPC*1100 MPC=ΔC/ΔY Change in Income ΔY=1300-1100=200 Change in Con ΔC=805-695=110 MPC=110/200 = 0.55 695= a+ MPC*1100 695=a+0.55*1100 695=a+605 a=695-605 =90
Algebraically, the consumption function is represented as ________.
C = a + MPC*Y, where a is autonomous consumption (the amount of consumption expenditure when Y = 0), MPC is the marginal propensity to consume, and Y is national income
What function is a horizontal line when Aggregate Expenditure = C + I + G + (X - M)?
Government spending
Which of the following is NOT true about government spending as function of national income?
Government spending will fluctuate.
Which calculation for the multiplier is the correct description of the equation?
Change in real GDP / change in autonomous expenditure. Autonomous expenditure is a type of spending that is considered automatic and necessary. It can also be written as (1−MPC).
Suppose an economy is defined by the following: C = $210 + 0.8 (Yd). This algebraic equation represents the ________.
Consumption function
Which of the following is true about government spending as function of national income?
Government spending appears as a horizontal line on the Keynesian cross diagram. Aggregate expenditures would shift upward if government spending increased. Federal, state and local governments determine the level of government spending through the budget process.
Autonomous expenditure does NOT depend on what factor?
GDP/output
Suppose that the level of income is $1800 and the tax rate is 0.1 %. Given this data, what is the level of disposable income?
Disposable income = Income - Taxes Taxes = 1800 x .1 1800-180 = 1620
Consider national income, which statement is accurate about the function of export and imports in it?
Exports and imports are horizontal lines with imports being negative as it relates to real GDP.
What happens to firms in an economy that are to the right side of the macroeconomic equilibrium?
Firms will respond by decreasing their level of production and GDP will fall. This is when the real output is greater than the aggregate expenditure in the economy. Firms will not sell as expected and inventories will build up which will cause them to reduce production until inventories are again at desired levels. Over time this scenario can reduce GDP and employment.
In the figure, the spending multiplier is represented by ΔY/ΔAE and ________.
Graphically by the increase in the AE line
Which of the following statements is incorrect regarding the potential GDP line?
It assumes less than full employment of its labor and physical capital.
Looking at the figure above, why does the line for the consumption function not start at zero?
It does not start a zero because of autonomous consumption
This year the economy is takes a hit as another housing market bubble bursts and there is every expectation that the economy is in for a rough patch. What would most likely take place for the consumption function with this lack of confidence in the economy?
It will shift the consumption function downward.
This year the economy is strong and there is every expectation that it will continue to be strong over the next few years. With this confidence in the economy, what would most likely happen to the consumption function?
It will shift the consumption function upward.
The potential GDP line is a vertical line on the ________ indicating where GDP is at potential on the horizontal axis.
Keynesian Cross diagram
Which line represents the C + I + G stacked functions in the graph?
Line 3
Given this data, what is Marginal Propensity to Consume (MPC)?
MPC= Change in C / Change in Y Change in Y = 1300 - 1100 = 200 Change in C = 805-695= 110 110 / 200 = .55
Given this data, what is Marginal Propensity to Import (MPI)?
MPI= Change M / Change Y Change in Y = 2040 - 1800= 240 Change in M= 714-630 = 84 84 / 240 = .35
Given this data, what is Marginal Propensity to Save (MPS)?
MPS= Change in C / Change in Y 90/200= .45
It is important to remember when calculating the spending multiplier to determine government spending (in order to influencing the economy), the ________ in the income-expenditure model is found at the point where the level of GDP/national income equals aggregate expenditure.
Macro equilibrium
When describing the economy's aggregate expenditure components impacted by the real level of income, which of the following terms is excluded from that description?
Macroeconomic Equilibrium
Suppose an economy is defined by the following: C = 150 + 0.7 (Yd). The 0.7 in this algebraic equation represents the ________.
Marginal propensity to consume
In order to bring the economy back to its potential GDP/full employment level, what is vital to remember when calculating the spending multiplier in order to discover the amount of government spending needed?
Need to remember that Y (national income) = AE (aggregate expenditure).
Consumption still exists even if income is zero because ________.
People still have basics needs they must meet
Considering the figure, the macro equilibrium which is where aggregate expenditure is equal to national income is represented by ________.
Point b
Consider the following information for Mexico. What is the equilibrium level of GDP in the income-expenditure model? Suppose that there is a decrease in Investment by $40. What is the difference between the original and new GDP as a result of a decrease in Investment?
Question 1. Y = C + I + G + X - M C= 200 +.6(Y-T) I= 800 G= 400 X= 40 M= 0.4 T=0.2 Y = C + I + G + X - M Y = 200 + .6 (Y-0.2Y) + 800 + 400 + 40 - 0.4Y 1565.2173913043 Question 2. I= 800 - 40 = 760 Y = 200 + .6 (Y-0.2Y) + 760 + 400 + 40 - 0.4Y 1521.7391304348 Question 3. -43.478260869565
The aggregate expenditure determines the total amount that firms and households plan to spend on goods and services at each level of income. Therefore this model focuses on the short run relationship between ________ and national income or GDP.
Real spending
autonomous consumption:
The amount consumers spend if their income was zero; i.e. consumer spending which is caused by something other than income, for example, borrowing
The current economic policy being implemented by the Keynesian economists in government is moving the economy bach toward potential GDP through increased taxation. Knowing this policy, what would you say is the current state of the economy?
The economy is experiencing an inflationary gap.
How does an economist know if the economy is experiencing an inflationary gap?
The equilibrium level of GDP is greater than potential GDP.
What are the components used to create a consolidation view or stacked graph (or stacking on top of each other) of the aggregate expenditure function?
The graph would include the consumption function (after taxes), the investment function, and the government spending function, and the net export function.
According to the graph, which statement is accurate?
The increase in equilibrium output is larger than the increase in expenditure (AE0 to AE1).
In the figure, which of the following is true?
The increase in expenditure (AE0 to AE1) is smaller than the increase in equilibrium output.
Which of the below is true about investment as function of national income?
The investment function can be drawn as a horizontal line.
What is a very important piece of information to remember when calculating the spending multiplier which determines the level of government spending to impact the economy?
The macro equilibrium in the income-expenditure model is found at the point where the level of GDP/national income equals aggregate expenditure.
In the figure, ΔY/ΔAE represents the spending multiplier, but how is it represented graphically?
The spending multiplier is represented by the increase in the AE line.
As an economist George is analyzing a consumption function graph and notices that the slope has flattened. What would cause this to occur?
There was an decrease in the Marginal Propensity to Consume (MPC).
Sandra, an economist is discussing a consumption function graph and sees that the slope has steepened from a prior graph. What would cause this change in the consumption function?
There was an increase in the Marginal Propensity to Consume (MPC) (WRONG)
Of the following explanations of the short run aggregate supply curve, which best explains the relatively horizontal area?
With an economy operating below potential output, an increase in aggregate demand causes real output to increase with no or little effect on the price level.
It is important to remember ________ when calculating the spending multiplier to determine government spending in order to return the economy to potential GDP/full employment.
Y (national income) = AE (aggregate expenditure)
Imagine the economy is defined by the consumption function of C = 140 + 0.9 (Yd) where 140 is autonomous consumption, 0.9 is marginal propensity to consume, and Yd is disposable income (after taxes) and Yd=Y-T, where Y is national income (or GDP) and T=Tax Revenues=0.3Y (0.3 is the avg. income tax rate). To find the macro equilibrium use the following equation Y = C + I + G + (X - M). Where C=140 + 0.9(Yd), I=400, G=800, X=600, M=0.15Y. What is the aggregate expenditure for this economy? [Remember Y=AE]
Y = $3731 Y = C + I + G + (E-I) Y = 140 + .9 (Y-.3Y) + 400+800+(600-.15Y) Y = .63 Y + 1940 -.15Y Y = 1940/(1+.15-.63) Y = 3730.76 or 3731
Consider the following infomation for Japan. What is the equilibrium level of GDP in the income-expenditure model?
Y = C + I + G + X - M C= 210 +.7(Y-T) I= 800 G= 400 X= 20 M= 0.15 T=0.05 Y = C + I + G + X - M Y = 210 + .7 (Y-0.05Y) + 800 + 400 + 20 - 0.15Y 2948.4536082474
Suppose that there is an increase in Exports by $20. What is the new equilibrium level of GDP in the income-expenditure model? What is difference between the original and new level of GDP as a result of an increase in Exports?
Y = C + I + G + X - M C= 210 +.7(Y-T) I= 800 G= 400 X= 20 + 20 = 40 M= 0.15 T=0.05 Y = C + I + G + X - M Y = 210 + .7 (Y-0.05Y) + 800 + 400 + 240 - 0.15Y Calculator = 2989.6907216495 Diff 41.237113402062
Consider the following information the U.S. What is the equilibrium level of GDP in the income-expenditure model?
Y = C + I + G + X - M, where Y is the equilibrium income, C is the consumption, I is the investment, G is the government expenditure, X is the export and M is the import. C=420 + 0.85(Y-T) I=1,000 G=300 X=10 M=0.3Y T=0.3 Y = C + I + G + X - M Y=420 + 0.85(Y-0.3Y) + 1,000 + 300 + 10 - 0.3Y Y=1,730 + 0.295Y Y- 0.295Y=1,730 0.705Y=1,730 Y=1,730/0.705 Y=2453.9007092199
Causes of a recessionary gap include ________.
a decline in consumption
If firms are at macro equilibrium, then ________. Which statement is not true?
aggregate expenditure will not equal GDP/national income It is a point of balance where no incentive exists to shift away from that outcome. Inventories are in line and expectations/predictions have been met.
If the economy is operating below the natural rate of unemployment, then the economy is typically operating ________ potential GDP.
above When the economy is operating below the natural rate of unemployment, typically around 5%, it means it is a time of expansion with low unemployment. This means that output is being created and GDP is high.
A key part of the Income-Expenditure model is understanding that as GDP (or national income) rises, so does ________.
aggregate expenditure
Income = Expenditure Line:
all combinations of national income and aggregate expenditure where national income equals aggregate expenditure; graphically, this is the 45 degree line on the Keynesian Cross diagram (or income-expenditure model)
Autonomous Expenditures:
all the components of aggregate expenditure, which do not vary with national income; these include autonomous consumption, investment, government, and export expenditures
Looking at the figure above, the reason why the consumption function line does not start at zero is due to ________.
autonomous consumption
Which factor other than income can also cause the entire consumption function to shift?
changes in wealth
During an inflationary gap due to overly sufficient aggregate demand, the government should ________ spending by an amount determined by the spending multiplier in an attempt to return the economy to potential GDP/full employment.
decrease
If the macroeconomy is experiencing an inflationary gap, what actions would a Keynesian economist suggest be taken to adjust the economy?
decrease government spending
Suppose an economy is defined by the following: C = 136 + 0.9 (Yd). The (Yd) in this algebraic equation represents the ________.
disposable income
consumption function:
graphical relationship between national income and consumption expenditure; algebraically: C = a + MPC*Y, where a is autonomous consumption (the amount of consumption expenditure when Y = 0), MPC is the marginal propensity to consume, and Y is national income
Net Export Function:
graphical relationship between national income and net exports (export expenditures minus import expenditures)
Aggregate Expenditure Function:
graphical relationship between national income as a function of aggregate expenditure, which is defined as consumption plus investment plus government spending plus net exports
Government Spending Function:
horizontal line showing the relationship between national income and government spending
Investment Expenditure Function:
horizontal line showing the relationship between national income and investment expenditure
All of the following are components of the aggregate expenditure model except ________.
import spending
The consumption function is a graphical relationship between ________.
income and consumer spending
The income-expenditure model illustrates imbalances or inefficiency in ?
levels of output or national income
In the figure, which line is the potential GDP Line?
line 1
Suppose an economy is defined by the following: C = 150 + 0.7 (Yd). The 0.6 in this algebraic equation represents the ________.
marginal propensity to consume
If the consumption function is C = 34 + 0.7y and disposable income decreases by $50, what will happen to autonomous consumption?
nothing By definition, autonomous consumption is independent of disposable income and is the minimum level of spending that must be made for basic needs.
An increase in the Marginal Propensity to Consume (MPC) ________ the consumption function.
steepens
The combination of the aggregate expenditure line and the income=expenditure line (i.e. the 45 degree line) is called ________.
the Keynesian Cross
What is the term used when the income=expenditure line (i.e. the 45 degree line) and the aggregate expenditure line are combined on a graph?
the Keynesian Cross
The long-run aggregate supply curve is ________.
vertical This is because the income-expenditure model assumes that the long-run aggregate supply curve has changes in the price level have no effect on real output. This makes sense since potential GDP means all resources are fully employed so it's not possible to produce more output. Thus, any increase in AD can only lead to inflation.
potential GDP line:
vertical line on the Keynesian Cross diagram indicating where GDP (on the horizontal axis) is at potential
inflationary gap:
when macro equilibrium occurs at a level of GDP greater than potential GDP; thus, unemployment is lower than the natural rate
recessionary gap:
when macro equilibrium occurs at a level of GDP less than potential GDP; thus, unemployment is higher than the natural rate
