Chapter 12

Assume that the multiplier in a country is equal to 10 and that autonomous real consumption spending is ​$5 trillion. If current real GDP is ​$20 ​trillion, the current value of real consumption spending is ​$__ trillion.

$23 trillion

Multiplier (formula)

= (1 / (1 - MPC)) or = 1 / MPS

MPC (formula)

= Change in Real Consumption / Change in Real Disposable Consumption

MPS (formula)

= Change in Real Saving / Change in Disposable Income

Disposable Income (formula)

= Consumption + Saving

Saving (formula)

= Disposable income - Consumption

Change in equilibrium real GDP (formula)

= Multiplier x Change in Autonomous Spending

APC (formula)

= Real Consumption / Real Disposable Income

APS (formula)

= Real saving / Real Disposable Income

Lump-sum tax

A tax that does not depend on income. An example is a $1,000 tax that every household must pay, irrespective of its economic situation.

Life-cycle theory of consumption

A theory in which a person bases decisions about current consumption and saving on both current income and anticipated future income.

Permanent income hypothesis

A theory of consumption in which an individual determines current consumption based on anticipated average lifetime income.

If the level of consumption is​ $120 billion and disposable income is​ $150 billion, then the A. APC​ = 0.8 and saving is positive. B. APC​ = 0.8 and saving is negative. C. APC​ = 0.75 and saving is positive. D. APC​ = 0.75 and saving is negative.

A. APC​ = 0.8 and saving is positive.

Which of the following is a true​ statement? A. The C​ + I​ + G​ + X curve is used to derive the aggregate demand​ curve, but the C​ + I​ + G​ + X curve is drawn for one price level while price levels vary along the aggregate demand curve. B. Both the C​ + I​ + G​ + X curve and the aggregate demand curve are drawn for one price level. C. The C​ + I​ + G​ + X curve is used to derive the aggregate demand​ curve, but the aggregate demand curve is drawn for one price level. D. The C​ + I​ + G​ + X curve has no relationship to the aggregate demand curve other than some of the variables that affect one curve also affect the other.

A. The C​ + I​ + G​ + X curve is used to derive the aggregate demand​ curve, but the C​ + I​ + G​ + X curve is drawn for one price level while price levels vary along the aggregate demand curve.

Which of the following statements is true when considering an economy with an​ upward-sloping short-run aggregate supply​ curve? A. The multiplier has more impact when the economy is experiencing a recessionary gap compared to an inflationary gap. B. The multiplier has an equal but muffled impact when there is either a recessionary or inflationary gap. C. The multiplier has more impact when the economy is experiencing an inflationary gap compared to a recessionary gap. D. The multiplier has its full effect no matter what the economy is experiencing.

A. The multiplier has more impact when the economy is experiencing a recessionary gap compared to an inflationary gap. This is because the rise in the price level is much smaller when there is a recessionary gap as opposed to an inflationary gap.

An increase in the interest rate causes A. a decrease in the amount of real planned investment. B. an increase in the investment function. C. a decrease in the investment function. D. a decrease in disposable income

A. a decrease in the amount of real planned investment. Any change in the interest rate causes a movement along the investment function. It does not cause a shift in the function.

If society wants aggregate demand to increase without changes in the price​ level, then there must be A. an increase in autonomous spending and a horizontal short−run aggregate supply curve. B. an increase in autonomous saving so that autonomous investment spending can increase. C. an increase in autonomous spending combined with an increase in the marginal propensity to save. D. a gap between full employment and the current level of real GDP and an increase in autonomous spending.

A. an increase in autonomous spending and a horizontal short−run aggregate supply curve.

Saving is the portion of A. disposable income that is not consumed. B. stock of consumption. C. disposable income that is consumed. D. investment that is spent on machinery.

A. disposable income that is not consumed.

The ratio of the change in the equilibrium level of real GDP to the change in autonomous real expenditures is the A. multiplier. B. marginal propensity to consume. C. average propensity to consume. D. unplanned investment.

A. multiplier.

The multiplier is weakened in inflationary gaps because of A. rapid price level increases. B. incomes rising faster than the price level. C. increasing returns. D. economies of scale.

A. rapid price level increases. As the price level increases more​ rapidly, purchasing power decreases more rapidly too.

Some Relationships

APC + APS = 1 (100 percent of total income) MPC + MPS = 1 (100 percent of the change income)

Which one of the following statements is​ true? A. Over the​ years, real consumption spending has been more volatile than real investment spending. B. Over the​ years, real investment spending has been more volatile than real consumption spending. C. In the Keynesian​ model, changes in the volume of real investment spending are fully explained by changes in the real interest rate. D. Domestic real investment in the United States was highest during the Great Depression.

B. Over the​ years, real investment spending has been more volatile than real consumption spending.

Expenditures by firms on new machines and buildings that are expected to yield a future stream of income is known as A. inventory investment. B. fixed investment. C. consumption goods. D. consumer durable.

B. fixed investment.

In order to understand the outcomes of a model it is necessary to know the assumptions of a model. In the Keynesian​ model, businesses A. have retained earnings. B. pay no indirect taxes. C. pay only sales tax. D. earn no profit. The Keynesian model assumes that international trade A. plays a large role since trade is an important part of every economy. B. plays no role in the simple model. C. has imports equal to a​ country's exports for simplicity. D. plays a small role since exports and imports are minimal for most countries.

B. pay no indirect taxes. B. plays no role in the simple model.

Planned real investment is determined by the A. the marginal tax rate. B. rate of interest. C. the marginal propensity to save. D. money supply.

B. rate of interest. There is an inverse relationship between the interest rate and the amount of investment. As the interest rate​ falls, more projects become profitable. This leads to greater investment.

The terms​ "saving" and​ "savings" differ in that A. savings can be​ negative, but saving cannot. B. savings are a​ stock, and saving is a flow. C. saving is a​ stock, and savings are a flow. D. saving always exceeds savings.

B. savings are a​ stock, and saving is a flow.

With regard to the relationship between the C​ + I​ + G​ + X curve and the aggregate demand​ curve, changes in the price level cause A. the aggregate demand curve to shift while it causes a movement along the C​ + I​ + G​ + X curve. B. the C​ + I​ + G​ + X curve to shift while it causes a movement along the aggregate demand curve. C. a movement along both the aggregate demand and C​ + I​ + G​ + X curves. D. a shift of both the aggregate demand and C​ + I​ + G​ + X curves.

B. the C​ + I​ + G​ + X curve to shift while it causes a movement along the aggregate demand curve.

In the Keynesian​ model, whenever planned saving is more than planned investment A. the interest rate will remain unchanged. B. there will be unplanned inventory accumulation. C. real GDP will not be influenced. D. there will be unplanned inventory depletion.

B. there will be unplanned inventory accumulation.

Which of the following statements best reflects the relationship between saving and savings​? A. Saving and savings are both stock variables. B. Saving and savings are both flow variables. C. Saving is a flow​ variable; savings is a stock variable. D.Saving is the total amount not consumed whereas savings refers to the amount placed into a savings account.

C. Saving is a flow​ variable; savings is a stock variable.

If real GDP rises aboverises above total planned expenditures the economy will see A. production decreases and employment increases. B. production and employment increases. C. production and employment decreases. D. production increases and employment decreases.

C. production and employment decreases. Whenever total planned real expenditures are less than real GDP, the opposite occurs. There are unplanned inventory increases, causing firms to cut back on their production of goods and services in an effort to push inventories back down to planned levels. The result is a drop in real GDP toward the equilibrium level.

Autonomous real investment spending is A. the level of investment expenditure that would prevail if interest rates were zero. B. the level of investment expenditure required to keep the economy expanding at its current growth rate. C. the level of investment expenditure that is independent of real GDP. D. the level of investment expenditure required to replace capital lost to depreciation.

C. the level of investment expenditure that is independent of real GDP.

Total Expenditures

C​ + I​ + G​ + X.

All of the following will cause the planned investment function to shift rightward except A. a decrease in business taxation. B. an increase in expected profits. C. an improvement in technology. D. a decrease in the interest rate.

D. a decrease in the interest rate. Any change in the interest rate causes a movement along the investment function. It does not cause a shift in the function.

If the marginal propensity to consume​ (MPC) is 0.8 and there is a desire to increase real GDP by​ $400 billion, then A. an increase in planned real investment spending of​ $100 billion will generate this change. B. an increase in autonomous real consumption spending of​ $80 billion will generate this change. C. a decrease in autonomous real saving of​ $400 billion will generate this change. D. an increase in real autonomous spending of​ $80 billion will generate this change.

D. an increase in real autonomous spending of​ $80 billion will generate this change.

Investment is A. a positive function of real GDP. B. a positive function of interest rates. C. a negative function of real GDP. D. autonomous with respect to real GDP.

D. autonomous with respect to real GDP.

The consumption function shows the relationship A. between government spending and tax collection. B. between the relative prices of goods and the total amount of household consumption spending. C. between consumption spending and capital gains. D. between​ households' disposable income and their consumption spending.

D. between​ households' disposable income and their consumption spending.

In the Keynesian model equilibrium national income A. equals planned​ consumption, investment,​ government, and import expenditures. B. occurs at the point where the consumption function crosses the​ 45-degree line. C. occurs when the marginal propensity to consume equals the multiplier. D. equals planned​ consumption, investment,​ government, and net export expenditures.

D. equals planned​ consumption, investment,​ government, and net export expenditures. Total expenditures are C​ + I​ + G​ + X.

In the Keynesian​ model, planned investment is inversely related to A. positively related to the wage rate. B. positively related to household consumption. C. negatively related to the level of income. D. negatively related to the interest rate.

D. negatively related to the interest rate.

Saving differs from savings in that A. saving is both a flow and a stock while savings is a stock. B. saving is a stock while savings is a flow. C. saving is a stock while savings is a flow. D. saving is a flow while savings is a stock.

D. saving is a flow while savings is a stock.

When the marginal propensity to consume​ increases, A. the multiplier remains unchanged. B. the average propensity to save remains unchanged. C. the multiplier decreases. D. the multiplier increases.

D. the multiplier increases.

If the MPC​ = 0.8 and planned autonomous investment increases by​ $80 billion, then equilibrium real GDP will increase by A. ​$320 billion. B. ​$64 billion. C. ​$80 billion. D. ​$400 billion.

D. ​$400 billion.

If the marginal propensity to save is 0.4 and disposable income increases from​ $1,000 to​ $2,000, saving will increase A. ​$200. B. ​$300. C. ​$100. D. ​$400.

D. ​$400.

Consumption Goods

Goods bought by households to use up, such as food and movies.

The Keynesian Theory of Consumption and Saving

Keynes argued that real consumption and saving decisions depend primarily on a household's current real disposable income.

Saving function

Mathematically, the saving function is the complement of the consumption function because consumption plus saving always must equal disposable income. What is not consumed is, by definition, saved.

Dissaving

Negative saving; a situation in which spending exceeds income. Dissaving can occur when a household is able to borrow or use up existing assets.

What Causes the Investment Function to Shift?

One of those variables is the expectations of businesses. If higher profits are expected, more machines and bigger plants will be planned for the future. More investment will be undertaken because of the expectation of higher profits. Any change in productive technology can potentially shift the investment function. A positive change in productive technology would stimulate demand for additional capital goods and shift I outward to the right. Changes in business taxes can also shift the investment function. If they increase, we predict a leftward shift in the planned investment function because higher taxes imply a lower (after-tax) rate of return.

Capital goods

Producer durables; nonconsumanble goods that firms use to make other goods.

Real Disposable Income

Real GDP minus net taxes, or after-tax real income.

Average propensity to consume (APC)

Real consumption divided by real disposable income. For any given level of real income, the proportion of total real disposable income that is consumed.

Average propensity to save (APS)

Real saving divided by real disposable income. For any given level of real income, the proportion of total real disposable income that is saved.

Recall that the consumption function is given as C​ = a​ + bY​, where a is autonomous consumption and b is the MPC. In​ addition, the multiplier is given by ​1/(1minus−​MPC).

Recall that the consumption function is given as C​ = a​ + bY​, where a is autonomous consumption and b is the MPC. In​ addition, the multiplier is given by ​1/(1minus−​MPC).

Investment

Spending on items such as machines and buildings, which can be used to produce goods and services in the future. (It also includes changes in business inventories.) The investment part of real GDP is the portion that will be used in the process of producing goods and in the future. In economic analysis, investment primarily is defined to include expenditures on new machines and buildings—capital goods—that are expected to yield a future stream of income. This is called fixed investment. We also include changes in business inventories in our definition. This we call inventory investment.

Consumption

Spending on new goods and services to be used up out of a household's current income. Whatever is not consumed is saved. Consumption includes such things as buying food and going to a concert.

Saving

The act of not consuming all of one's current income. Whatever is not consumed out of spendable income is, by definition, saved. Saving is an action measured over time (a flow), whereas savings are a stock, an accumulation resulting from the action of saving in the past.

45-Degree Reference Line

The line among which planned real expenditures equal real GDP per year.

Autonomous Consumption

The part of consumption that is independent of (does not depend on) the level of disposable income. Changes in autonomous consumption shift the consumption function.

Break-even income point

The point in which there is neither positive nor negative real saving. Point F of Figure 12-1

Marginal propensity to save (MPS)

The ratio of the change in saving in the change in disposable income. A marginal propensity to save of 0.2 indicates that out of an additional $100 in take-home pay, $20 will be saved. Whatever is not saved is consumed. The marginal propensity to save plus the marginal propensity to consume must always equal 1, by definition.

Multiplier

The ratio of the change in the equilibrium level of real GDP to the change in autonomous real expenditures. The number by which a change in autonomous real investment or autonomous real consumption, for example, is multiplied to get the change in equilibrium real GDP.

Marginal propensity to consume (MPC)

The ration of the change in consumption to the change in disposable income. A marginal propensity to consume of 0.8 tells that an additional $100 in take-home pay will lead to an additional $80 consumed. The marginal propensity to consume plus the marginal propensity to save must always equal 1, by definition.

Consumption function

The relationship between amount consumed and disposable income. A consumption function tells you how much people plan to consume at various levels of disposable income.

How the values of MPC and MPS affect the Multiplier

The smaller the marginal propensity to save, the larger the multiplier. Otherwise stated: the larger the marginal propensity to consume, the larger the multiplier.

Net wealth

The stock of assets owned by a person, household, firm, or nation (net of any debts owed). For a household, net wealth can consist of a house, cars, personal belongings, stocks, bonds, bank accounts, and cash (minus any debts owed).

How is investment defined as an economic​ concept? A. Investment is primarily the market value of all​ equipment, buildings, and inventories held by​ corporations, partnerships, and proprietorships. B. Investment is primarily the market value of all shares of stock held by the public. C. Investment is primarily the sum of expenditures by businesses on new capital goods that will yield a future stream of income. D. Investment is primarily the portion of your savings held in an​ interest-earning account.

businesses on new capital goods that will yield a future stream of income.

Accounting Identity

meaning that it has to hold true at every moment in time.