Homework 3 - econ
politicians are more interested in reelection than in stabilizing the economy
A political business cycle is the idea that
The consumption schedule will shift upward and the saving schedule will shift downward given the increase in wealth.
A sharp, sustained increase in stock prices.
The consumption schedule will shift upward and the saving schedule will shift downward as individuals borrow (decrease saving) and purchase automobiles (increase consumption).
A substantial increase in household borrowing to finance auto purchases.
GDP will fall If real GDP is $240, aggregate expenditures of $210 will result in positive unplanned inventory investment. GDP will fall as firms respond to the inventory build-up by reducing output.
If real GDP in an economy is currently $240, Ca is $120, Ig is $60, Xn is −$10, and G is $40, will the economy's real GDP rise, fall, or stay the same?
$15 billion. Explanation: Equilibrium GDP will increase by $15 billion. We know this is true because the change in equilibrium GDP is equal to the value of the multiplier times the change in investment. For the numbers given in this problem, the change in equilibrium GDP will be 5 × $3 billion, or $15 billion.
If the multiplier is 5 and investment increases by $3 billion, equilibrium real GDP will increase by:
0.80
In year 1, Adam earns $1,000 and saves $100. In year 2, Adam gets a $500 raise so that he earns a total of $1,500. Out of that $1,500, he saves $200. What is Adam's MPC out of his $500 raise?
The consumption schedule will shift downward and the saving schedule will shift upward because the expectation of future income has decreased (people will have to wait longer to start receiving income from Social Security).
A 5-year increase in the minimum age for collecting Social Security benefits.
reduce; reduce; reduce
A depression abroad will tend to __________ our exports, which in turn will __________ net exports, which in turn will __________ equilibrium real GDP.
interest-rate effect
A higher price level increases the cost of borrowing, which causes people to buy fewer cars.
The consumption schedule will shift downward and the saving schedule will shift upward given the decrease in wealth.
A large decrease in real estate values, including private homes.
real-balances effect
A lower price level causes restaurants to become busier as more people purchase restaurant meals.
a reduction in investment spending caused by an increase in interest rates arising from an increase in government spending.
The crowding-out effect is
a recessionary; $5 billion
The economy's current level of equilibrium GDP is $780 billion. The full-employment level of GDP is $800 billion. The multiplier is 4. Given those facts, we know that the economy faces __________ expenditure gap of __________.
in the time it takes to identify the situation, enact a policy, and allow it to work, economic circumstances may have changed
The problem of time lags in enacting and applying fiscal policy is
net exports and the government sector.
The two expenditure components of real GDP purposely excluded in a private closed economy are
supply decreases
f. A hurricane destroys manufacturing plants.
demand decreases
g. A stock market crash reduces people's wealth.
demand increases
h. The spread of democracy around the world increases consumer confidence in the United States.
demand increases
i. The United States enters into an arms race with China, resulting in a significant increase in military spending.
-the price level is fixed -a horizontal
immediate short run
supply decreases
j. A revolution in Iran results in a significant reduction in the world's supply of oil.
supply increases
k. A new computer chip is developed that is faster and cheaper than previous chips.
-output is fixed -a vertical line
long run
Real GDP and disposable income are higher.
What is the fundamental reason that the levels of consumption and saving in the United States are each higher today than they were a decade ago?
Progressive tax system, because it increases at an increasing rate as incomes rise, thus having more of a dampening effect on rising (or falling) incomes
What type of tax system would have the most built-in stability?
foreign purchases effect
When the U.S. price level rises, Canadian consumers are more likely to buy cars made in Mexico than cars made in the United States
The real-balances effect explains the shape of the aggregate demand curve, whereas the wealth effect causes shifts of the aggregate demand curve. Explanation: The "real-balances effect" is one explanation of the inverse relationship between the price level and quantity of expenditures. The "wealth effect" assumes the price level is constant, but a change in consumer wealth causes a shift in consumer spending; the aggregate demand curve will shift.
Which of the following statements is true concerning the real-balances effect and the wealth effect?
-interest rates rise -there is an economic boom overseas that raises the incomes of the foreign households.
Which of the following will shift the aggregate demand curve to the left?
-a new networking technology increases productivity all over the economy -business taxes fall
Which of the following will shift the aggregate supply curve to the right?
-business taxes fall -a new networking technology increases productivity all over the economy
Which of the following will shift the aggregate supply curve to the right?
-raising taxes -decreasing government spending
Which of the following would help a government reduce an inflationary output gap?
demand decreases
a. Consumers become more pessimistic about the economy.
the MPC is the change in consumption divided by the change in income, whereas the APC is total consumption divided by total income.
a. The difference between the MPC and the APC is that
supply increases
b. Technological changes enable workers to be more productive.
all additional income must be spent or saved.
b. The sum of the MPC and the MPS must equal 1 because
supply increases
c. Manufacturing firms expect steel prices to decrease significantly.
supply decreases
d. Employers are required to provide paid sick leave to part-time as well as full-time employees.
demand increases
e. Government spending increases.
decline, the purchasing power of assets will rise, so spending at each income level should rise. Explanation: A change in the price level produces a real-balances effect. Here is how it works: A higher price level reduces the real value or purchasing power of the public's accumulated savings balances. In particular, the real value of assets with fixed money values, such as savings accounts or bonds, diminishes. Because a higher price level erodes the purchasing power of such assets, the public is poorer in real terms and will reduce its spending. Therefore, a higher price level means less consumption spending.
According to the "real-balances effect," if prices
a shift in consumer spending and a shift of the aggregate demand curve Explanation: The "wealth effect" assumes the price level is constant, but a change in consumer wealth causes a shift in consumer spending; the aggregate demand curve will shift. For example, the value of stock market shares may rise and cause people to feel wealthier and spend more. A stock decline can cause a decline in consumer spending.
According to the "wealth effect," a change in consumer wealth causes
The consumption schedule will shift upward and the saving schedule will shift downward because individuals expect to be earning higher income in the future.
An economywide expectation that a recession is over and that a robust expansion will occur.
A. An increase in aggregate demand. - The price level rises rapidly and there is little change in real output b. A decrease in aggregate supply, with no change in aggregate demand. - The price level rises and real output decreases. c. The price level rises and real output decreases. - The price level does not change, but real output increases d. A decrease in aggregate demand. - The price level does not change, but real output declines e. An increase in aggregate demand that exceeds an increase in aggregate supply. - The price level increases somewhat, with a relatively large change in output
Assume that (a) the price level is flexible upward but not downward and (b) the economy is currently operating at its full-employment output. Other things equal, how will each of the following affect the equilibrium price level and equilibrium level of real output in the short run?
taxes and government payouts
Built-in (automatic) stabilizers work by changing __________ so that changes in GDP are reduced.
$40 billion If the MPC is 0.67? $24 billion Explanation: First, we need to find the expenditure multiplier. The expenditure multiplier can be found by dividing 1 by 1 minus the marginal propensity to consume. The expenditure multiplier is 1/(1 − MPC). To find the change in GDP, we take the expenditure multiplier and multiply this value by the change in investment. a. For our first value, we have an expenditure multiplier of 5 [= 1/(1 − 0.80)]. For our first MPC value, the change in GDP equals $40 billion (= 5 × $8 billion). b. For our second value, we have an expenditure multiplier of 3.0303 [= 1/(1 − 0.67)]. Some students may round this to 3. For our second MPC, the change in GDP equals $24.24 billion (= 3.0303 × $8 billion) (or $24 billion if rounded to the nearest billion).
By how much will GDP change if firms increase their investment by $8 billion and the MPC is 0.80?
The variable on the vertical (y) axis is consumption Correctand the variable on the horizontal (x) axis is disposable income . These variables are directly related.
Consumption schedule
at this level of output, production creates sufficient total spending to purchase that output.
Equilibrium real GDP occurs where C + Ig = GDP in a private closed economy because
consumers may hesitate to increase their spending because they believe that tax rates will rise again
Expectations of a near-term policy reversal weaken fiscal policy because
reducing government spending, increasing taxes, or both.
Government's fiscal policy options for ending severe demand-pull inflation include
draw down inventories faster than planned, ordering will increase, and real GDP will rise.
If C + Ig exceeds GDP, the economy will
$210 Explanation: Equilibrium 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 = $120 + $60 + (−$10) + $40 = $210.
If Ca is $120, Ig is $60, Xn is −$10, and G is $40, what is the economy's equilibrium GDP?
A decline in the real interest rate will cause GDP to increase Explanation: This will increase interest-sensitive consumer purchases and investment, thus shifting the AE line upward, causing GDP to increase. An overall decrease in the expected rate of return on investment will cause GDP to decrease Explanation: Investment will decrease because of the lower expected rate of return, thus shifting the AE line downward, causing GDP to decrease. A sizable, sustained increase in stock prices will cause GDP to increase Explanation: This will increase consumption (because households will feel—or be—wealthier, or because they are hopeful about an expansion) and investment, thus shifting the AE schedule upward, causing GDP to increase.
Other things equal, what effect will each of the following changes independently have on the equilibrium level of real GDP in a private closed economy?
The variable on the vertical (y) axis is saving and the variable on the horizontal (x) axis is disposable income. These variables are directly related.
Saving schedule
a. What is the expected rate of return? 10% Explanation: 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. 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? Yes Will it invest in the machine if the real interest rate is 9 percent? Yes If it is 11%? No Explanation: anything above 10% interest rate is a bad investment
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.
There will be an inflationary expenditure gap and employment levels will be above the full-employment level. Explanation: Here we can use the same approach as in part a: AE = Ca + Ig + Xn + G = $170 + $60 + (−$10) + $40 = $260. Since full-employment (and full-capacity) output in the economy is $240, there will be an inflationary expenditure gap. Employment levels will be higher than the full-employment level.
Suppose that full-employment (and full-capacity) output in an economy is $240. If Ca is $170, Ig is $60, Xn is −$10, and G is $40, what will be the macroeconomic result?