Chapter 10 Macroeconomics

Refer to the table below. 1. Fill in the missing numbers in the table. 2. What is the breakeven level of income in the table? What is the term that economists use for the saving situation shown at the $240 level of income? 3. For each of the following items, indicate whether the value in the table is either constant or variable as income changes: the MPS, the APC, the MPC, the APS.

1. Consumption: 244, 260, 276, 292, 308, 324, 340, 356, 372 APC: 1.016, 1, .985, .973, .962, .952, 944, .936, .93 APS: -.016, 0, 0.014, .026, .037, .047, .055, .063, .07 MPS: .2 MPC: .8 2. The breakeven level is 260. At level $240, economist consider that dissaving (since the saving is negative). 3. The MPS and MPC are constant, while the APS and APC are variable

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. What is the expected rate of return? 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? Will it invest in the machine if the real interest rate is 9 percent? If it is 11 percent?

Expected rate of return= 10% The publisher would choose to invest if the real interest rate is 8 percent. The publisher would choose to invest if the real interest rate is 9 percent. The publisher would NOT choose to invest if the real interest rate is 11 percent.

Suppose that disposable income, consumption, and saving in some country are 200 billion,150 billion, and 50 billion, respectively. Next assume that disposable income increases by 20 billion, consumption rises by 18 billion, and saving goes up by $2 billion. What is the economy's MPC? Its MPS? What was the APC before the increase in disposable income? After the increase?

MPC= 0.9 MPS= 0.2 APC before the increase= 0.75 APC after the increase= 0.763

Suppose the wealth effect is such that $10 changes in wealth produce $1 changes in consumption at each income level. If real estate prices tumble such that wealth declines by 80, what will be the new level of consumption and saving at the 340 billion level of disposable income? The new level of saving?

New level of consumption= 316 New level of saving= 24

Assume there are no investment projects in the economy that yield an expected rate of return of 25 percent or more. But suppose there are $10 billion of investment projects yielding expected returns of between 20 and 25 percent; another $10 billion yielding between 15 and 20 percent; another 10 billion yielding between 15 and 20 percent; another $10 billion between 10 and 15 percent; and so forth. Cumulate these data and present them graphically, putting the expected rate of return (and the real interest rate) on the vertical axis and the amount of investment on the horizontal axis. What will be the equilibrium level of aggregate investment if the real interest rate is (a) 15 percent, (b) 10 percent, and (c) 5 percent?

The equilibrium level of aggregate investment is $20 billion when the real interest rate is 15%. The equilibrium level of aggregate investment is $30 billion when the real interest rate is 10%. The equilibrium level of aggregate investment is $40 billion when the real interest rate is 5%.

What are the variables (the items measured on the axes) in a graph of the (a) consumption schedule and (b) saving schedule? Are the variables inversely (negatively) related, or are they directly (positively) related? 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?

The variables in a consumption schedule graph are consumption and income. The variables in a saving schedule graph are saving and income. The variables are positively related. The consumption and saving levels are higher today than a decade ago because of the increase in income.

True or False: Large MPCs imply larger multipliers

True

Linear equations for the consumption and saving schedules take the general form C = a + bY and S = − a + (1 − b)Y, where C, S, and Y are consumption, saving, and national income, respectively. The constant a represents the vertical intercept, and b represents the slope of the consumption schedule. a. Use the following data to substitute numerical values for a and b in the consumption and saving equations. b. What is the economic meaning of b? Of (1 − b)? c. Suppose that the amount of saving that occurs at each level of national income falls by \)20 but that the values of b and (1 − b) remain unchanged. Restate the saving and consumption equations inserting the new numerical values, and cite a factor that might have caused the change.

a. C= 80+0.6Y S= -80 + (1- 0.6)Y b. (1-b) is the marginal propensity to save c. C= 100+0.6Y S= -100 + (1- 0.6)Y

Suppose that an initial $10 billion increase in investment spending expands GDP by $10 billion in the first round of the multiplier process. If GDP and consumption both rise by $6 billion in the second round of the process, what is the MPC in this economy? What is the size of the multiplier? If GDP and consumption both rose by $8 billion in the second round, what would have been the size of the multiplier?

a. MPC= 0.6 b. Multiplier for $6 billion= 2.5 c. Multiplier for $8 billion= 5

Suppose that the linear equation for consumption in a hypothetical economy is C = 40 + 0.8Y. Also, suppose that income (Y) is $400. Determine a. the marginal propensity to consume, b. the marginal propensity to save, c. the level of consumption, d. the average propensity to consume, e. the level of saving, and f. the average propensity to save.

a. MPC= 0.8 b. MPS= 0.2 c. Level of consumption= 360 d. the average propensity to consume= 0.9 e. Level of savings= $40 f. the average propensity to save= 0.1

What will the multiplier be when the MPS is 0, 0.4, 0.6, and 1? What will it be when the MPC is 1, 0.90, 0.67, 0.50, and 0? How much of a change in GDP will result if firms increase their level of investment by $8 billion and the MPC is 0.80? If the MPC instead is 0.67?

a. MPS multiplier = undefined, 2.5, 1.67, 1 b. MPC multiplier = 0, 10, 3.03, 2, and 1 c. 40 billion d. 24.24 billion

In what direction will each of the following occurrences shift the consumption and saving schedules, other things equal? a. A large decrease in real estate values, including private homes. b. A sharp, sustained increase in stock prices. c. A 5-year increase in the minimum age for collecting Social Security benefits. d. An economywide expectation that a recession is over and that a robust expansion will occur. e. A substantial increase in household borrowing to finance auto purchases.

a. The consumption and saving schedule will shift to the left ( because consumption and saving will be declining) b. The consumption and saving schedule will remain the same. c. The consumption and saving schedule will shift to the right. d. The consumption schedule will shift to the right, and the saving schedule will shift to the left. e. The consumption schedule will shift to the right, and the saving schedule will shift to the left.

Refer to the table in Figure 10.5 and suppose that the real interest rate is 6 percent. Next, assume that some factor changes such that the expected rate of return declines by 2 percentage points at each prospective level of investment. Assuming no change in the real interest rate, by how much and in what direction will investment change? Which of the following might cause this change: (a) a decision to increase inventories; (b) an increase in excess production capacity?

a. The investment will decline by $5 billion, and the investment curve will shift toward the left. b. an increase in excess production capacity is the cause of investment decline.

If the MPS rises, then the MPC will a. fall b. rise c. stay the same

a. fall

Irving owns a chain of movie theaters. He is considering whether he should build a new theater downtown. The expected rate of return is 15 percent per year. He can borrow money at a 12 percent interest rate to finance the project. Should Irving proceed with this project? a. Yes b. No

a. yes

Real GDP is more volatile (variable) than gross investment. a. True b. False

b. False

Which of the following scenarios will shift the investment demand curve right? Select one or more answers from the choices shown. a. Business taxes increase. b. The expected return on capital increases. c. Firms have a lot of unused production capacity. d. Firms are planning on increasing their inventories.

b. The expected return on capital increase d. Firms are planning on increasing their inventories

In year 1, Anita earns $1,000 and saves $100. In year 2, Anita gets a $500 raise so that she earns a total of $1,500. Out of that $1,500, she saves $200. What is Anita's MPC out of her $500 raise? a. 0.5 b. 0.75 c. 0.80 d. 1.00

c. 0.8

If a $50 billion initial increase in spending leads to a $250 billion change in real GDP, how big is the multiplier? a. 1.0 b. 2.5 c. 4.0 d. 5.0

d. 5.0