macro ch 10-13

The multiplier will be

larger the larger the MPC and the smaller the MPS.

the equilibrium level of real GDP in a country is $410 billion. Suppose that planned investment increases by $3 billion. This increase causes real GDP to shift to a new equilibrium level of $470 billion. Instructions: In part a, enter your answer rounded to 1 decimal place. In part b, enter your answer rounded to 2 decimal places. a. What will be the size of the spending multiplier for this country? b. What will be its marginal propensity to save?

. When planned investment (or other spending) changes by a certain amount, the effect on real GDP is of a greater magnitude than the initial change in investment. This is because of the multiplier effect. The magnitude of the multiplier can be found by dividing the change in real GDP by the change in investment. For our example, the change in investment is $3 billion and the change in real GDP = $470 billion − $410 billion = $60 billion, so the multiplier = $60/$3 = 20. Note that the multiplier works in both directions, so when investment increases, real GDP increases by the multiplier times the increase in investment. When investment decreases, the change in investment is negative, so the change in real GDP will also be negative. However, the multiplier will always be positive because the change in real GDP always moves in the same direction as the change in investment. b. Another formula for the spending multiplier is: Multiplier = 1/MPS. We can use algebra to rearrange this equation to find MPS. Thus, MPS = 1/multiplier. Using the multiplier we calculated in part a, we get MPS = 1/20 = 0.05.

Suppose that an initial $20 billion increase in investment spending expands GDP by $20 billion in the first round of the multiplier process. Also assume that GDP and consumption both rise by $12 billion in the second round of the process. a. What is the MPC in this economy? b. What is the size of the multiplier? c. If, instead, GDP and consumption both rose by $16 billion in the second round, what would have been the size of the multiplier?

A: MPC = Δconsumption/Δincome = $12 billion/$20 billion = 0.6. B: Multiplier = 1/(1 − MPC) = 1/(1 − 0.6) = 2.5. C: MPC = Δconsumption/Δincome = $16 billion/$20 billion = 0.8. Given the MPC, we can find the multiplier, which equals 5. Multiplier = 1/(1 − MPC) = 1/(1 − 0.8) = 5

Suppose a handbill publisher can buy a new duplicating machine for $500 and the duplicator has a 1-year life. The machine is expected to contribute $550 to the year's net revenue. a. What is the expected rate of return? b: If the real interest rate at which funds can be borrowed to purchase the machine is 8 percent, will the publisher choose to invest in the machine?

A:The expected rate of return equals the expected net revenue less cost divided by the cost of the machine: Expected return = (net revenue − cost)/cost = ($550 − $500)/$500 = $50/$500 = 0.10, or 10 percent. B.. The firm will make this purchase only if the expected return is greater than or equal to the interest rate at which it can borrow. The logic is as follows. If you borrow $100 at an interest rate of 10 percent, then at the end of the year, you will owe $110. Now, if you can earn a rate of return of 20 percent on the borrowed $100, then you will have $120 from your investment at the end of the year. You pay off the $110 loan and keep $10. This is a good investment. However, if you earn a rate of return of 5 percent on the borrowed $100, then you will have $105 from your investment at the end of the year. You pay off the $110 loan and lose $5. This is a bad investment.

a. If buiness leaders invest a total of $10 billion of accumulated cash, what is the maximum expected change in GDP if Islandia's marginal propensity to consume is 0.6?

Multiplier = 1/(1 − MPC). In our example, the multiplier = 1/(1 − 0.6) = 2.5.' For our example, the increase in GDP = 2.5 × $10 billion = $25 billion

b. Suppose that the recent economic outlook in the country of Mountainia has been the opposite. Businesses are instead accumulating cash and postponing planned investments. If business leaders postpone $12 billion of planned investment spending, what is the maximum expected change in GDP if Mountainia's marginal propensity to save is 0.25?

Multiplier = 1/MPS. So, in this case, our multiplier = 1/0.25 = 4. Therefore, the change in GDP = 4 × −$12 billion = −$48 billion.

b. Suppose that the recent economic outlook in the country of Mountainia has been the opposite. Businesses are instead accumulating cash and postponing planned investments. If business leaders postpone $5 billion of planned investment spending, what is the maximum expected change in GDP if Mountainia's marginal propensity to save is 0.2?

Multiplier = 1/MPS. S o, in this case, our multiplier = 1/0.2 = 5. Therefore, the change in GDP = 5 × −$5 billion = −$25 billion.

c. Suppose that full-employment (and full-capacity) output in an economy is $210. If Ca is $160, Ig is $50, Xn is −$10, and G is $30, what will be the macroeconomic result?

Since full-employment (and full-capacity) output in the economy is $210, there will be an inflationary expenditure gap. Employment levels will be higher than the full-employment level.

If the slope of the aggregate expenditures schedule is 0.8, and aggregate expenditures decline by $4 billion, real GDP will

The ratio of decline in real GDP to the initial drop of expenditures would be a ratio of 5:1. That is, if expenditures decline by $4 billion, GDP should decline by $20 billion.

Which of the following statements is true concerning the real-balances effect and the wealth effect?

The real-balances effect explains the shape of the aggregate demand curve, whereas the wealth effect causes shifts of the aggregate demand curve.

The explanation for a downsloping aggregate demand curve differs from the explanation for the downsloping demand curve for a single product because

a downsloping, single-product demand curve assumes constant money income such that a lower price causes a substitution of the now relatively cheaper product for those whose prices have not changed.

According to the "wealth effect," a change in consumer wealth causes

a shift in consumer spending and a shift of the aggregate demand curve.

Real GDP, consumption, and the marginal propensity to consume (MPC) for five hypothetical countries are shown in the following table. Use the table to answer the questions below. a. Enter the current level of saving in the appropriate column in the table.

a. The residents of a country can either consume or save what they produce. Therefore, GDP = consumption + saving. If a country's consumption exceeds its GDP, then the difference must be funded through borrowing or the sale of assets. In that case, saving would be a negative number.

A full-strength multiplier applies to a decrease in aggregate demand when

aggregate supply is horizontal.

The sum of the MPC and the MPS must equal 1 because

all additional income must be spent or saved.

The view held by classical economists is that the economy will operate

at full employment on the production possibilities curve.

Equilibrium real GDP occurs where C + Ig = GDP in a private closed economy because

at this level of output, production creates sufficient total spending to purchase that output.

If real GDP in an economy is currently $210, Ca is $110, Ig is $50, Xn is −$10, and G is $30, will the economy's real GDP rise, fall, or stay the same?

b. If real GDP is $210, aggregate expenditures of $180 will result in positive unplanned inventory investment. GDP will fall as firms respond to the inventory build-up by reducing output.

Real GDP, consumption, and the marginal propensity to consume (MPC) for five hypothetical countries are shown in the following table. Use the table to answer the questions below. b. Now suppose that GDP increases by $60 billion in each of the five countries. What will be the new level of saving in each country? Enter your answers in the appropriate column in the table.

b. If the GDP of a country increases by $60 billion, a portion of the increase will be consumed and a portion will be saved. The portion of the increase that will be consumed can be found by multiplying the increase in GDP by the marginal propensity to consume. For example, for country A, increase in GDP × MPC = $60 billion × 0.95 = 57 billion. Since the remainder of the GDP increase will go to saving, we can find the increase in saving by subtracting the increase in consumption from the increase in GDP. For country A, $60 billion − $57 billion = $3 billion. Adding this amount to the previous amount of saving of $0 billion gives us a new saving amount of $3 billion for country A. A similar process can be used to find the new level of saving for the other countries.

If the slope of the aggregate expenditures schedule is 0.8, the multiplier will be

c. If the slope of the aggregate expenditures schedule is 0.8, then the MPC will equal 0.8 and the MPS will equal 0.2. Therefore, the multiplier will be 5 (= 1/0.2).

The multiplier

causes an initial change in spending to generate an even larger change in the aggregate demand curve.

According to the "real-balances effect," if prices

decline, the purchasing power of assets will rise, so spending at each income level should rise.

If C + Ig exceeds GDP, the economy will

draw down inventories faster than planned, ordering will increase, and real GDP will rise

A reduction in the real interest rate will increase investment spending, other things equal, because firms will make an investment purchase only if the expected return is

greater than or equal to the real interest rate at which it can borrow.

If Ca is $110, Ig is $50, Xn is −$10, and G is $30, what is the economy's equilibrium GDP?

ilibrium occurs where real output (Y) equals aggregate expenditures (AE), where AE = Ca + Ig + Xn + G. Using this relationship, we have the equilibrium value: Y = AE = Ca + Ig + Xn + G = $110 + $50 + (−$10) + $30 = $180.

The multiplier effect

intensifies the effect of a spending change, whether it is an increase or a decrease.

Saving is called a leakage because it

is a removal from the flow of aggregate consumption

Planned investment is called an injection because

it is an addition to the flow of aggregate spending.

Businesses in the nation of Islandia have been accumulating cash because they have a pessimistic outlook of the national economy. Due to recent changes in the economic outlook of Islandia, business leaders have started investing some of their accumulated cash. Instructions: Enter your answers as a whole number. Use a positive number to show an increase and a negative number to show a decrease. a. If business leaders invest a total of $40 billion of accumulated cash, what is the maximum expected change in GDP if Islandia's marginal propensity to consume is 0.6?

multiplier = 1/(1 − 0.6) = 2.5. GDP = 2.5 × $40 billion = $100 billion

The two expenditure components of real GDP purposely excluded in a private closed economy are

net exports and the government sector.

At equilibrium GDP, there will be

no unplanned inventories and no unplanned investment

A reduction in short-run aggregate demand in the actual economy reduces real output, rather than the price level, because

prices are inflexible downward.

Saving must equal planned investment at equilibrium GDP in a private closed economy because

spending and production will be the same, and there will be no unplanned inventory or GDP changes.

Say's law states that

supply creates its own demand.

The difference between the MPC and the APC is that

the MPC is the change in consumption divided by the change in income, whereas the APC is total consumption divided by total income.

The long-run aggregate supply curve is vertical because the economy's potential output is determined by

the availability and productivity of real resources, not by the price level.

A decrease in the aggregate expenditures schedule will cause a decline in real GDP that is greater than the decline in the aggregate expenditures schedule because

the decrease in the aggregate expenditures schedule is multiplied into a larger change in real GDP.

The downsloping aggregate demand curve can be explained by

the interest-rate effect, the real-balances effect, and the foreign purchases effect.

The magnitude of the drop in real GDP that occurs when aggregate expenditures fall depends on

the size of the marginal propensity to consume.

The short-run aggregate supply curve is relatively flat to the left of the full-employment output because

there are large amounts of unused capacity and idle human resources.

A downshift of the consumption schedule typically involves an equal upshift of the saving schedule.. The exception to this relationship occurs when

there is an increase in personal taxes, then consumption and saving both shift downward.

The shape of the short-run aggregate supply curve is

upsloping, because wages adjust more slowly than the price level.

Keynes's view on this matter is that the economy will operate

with some unemployment inside the production possibilities curve.