HW7- Chapter 10 Basic Economic Relationships

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 its MPS?

0.1

Suppose that the linear equation for consumption in a hypothetical economy is: C = 40 + 0.8Y Also suppose that income (Y) is $400. Determine the values for the following: f. APS =

0.1

Suppose that the linear equation for consumption in a hypothetical economy is: C = 40 + 0.8Y Also suppose that income (Y) is $400. Determine the values for the following: b. MPS =

0.2

c. What is the value of the marginal propensity to save?

0.2

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. b. What was the APC before the increase in disposable income?

0.75

f. For each of the following items, indicate whether the value in the table is either constant or variable as income changes:

The MPS is constant as income changes. The APC is variable as income changes. The MPC is constant as income changes. The APS is variable as income changes.

The nominal rate of interest is 8.5 percent, and the real rate is 5 percent. The expected rate of return on an investment is 8 percent. The firm should

undertake the investment because the expected rate of return of 8 percent is greater than the real rate of interest.

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.

downward; upward

If the MPS rises, then the MPC will:

fall

If the real rate of interest increases, then the level of investment in the economy will also increase.

false

The economic performance in the Great Recession of 2007-2009 clearly illustrated the relationship that if interest rates fall, then investment spending will increase.

false

The lower the marginal propensity to consume, the larger is the multiplier.

false

The multiplier will be larger, the steeper is the saving schedule.

false

The wealth effect will tend to decrease consumption and increase saving.

false

True or False: Real GDP is more volatile (variable) than gross investment.

false

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

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

The average propensity to save is equal to the percentage of total income that is saved.

true

The greater the MPC, the greater the multiplier.

true

A firm invests in a new machine that costs $2,000 a year but which is expected to produce an increase in total revenue of $2,200 a year. The current real rate of interest is 8 percent. The firm should

undertake the investment because the expected rate of return of 10 percent is greater than the real rate of interest.

In what direction will each of the following occurrences shift the consumption and saving schedules, other things equal? b. A sharp, sustained increase in stock prices.

upward; downward

In what direction will each of the following occurrences shift the consumption and saving schedules, other things equal? c. An economy-wide expectation that a recession is over and that a robust expansion will occur.

upward; downward

If DI is $275 billion and the APC is 0.8, we can conclude that saving is $55 billion.

true

Refer to the diagram. The break-even level of income is

$150

If people saved more of any extra income that they received, then the consumption schedule would become flatter.

true

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 was the APC after the increase?

0.764

In year one, 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?

0.8

Suppose that the linear equation for consumption in a hypothetical economy is: C = 40 + 0.8Y Also suppose that income (Y) is $400. Determine the values for the following: a. MPC =

0.8

b. What is the value of the marginal propensity to consume?

0.8

Refer to the given data for a hypothetical economy. The marginal propensity to consume is

0.80

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. a. What is the economy's MPC?

0.9

Suppose that the linear equation for consumption in a hypothetical economy is: C = 40 + 0.8Y Also suppose that income (Y) is $400. Determine the values for the following: d. APC =

0.9

With a marginal propensity to save of 0.4, the marginal propensity to consume will be

1.0 minus 0.4

d. What is the break-even level of income in the table?

260

Suppose that the linear equation for consumption in a hypothetical economy is: C = 40 + 0.8Y Also suppose that income (Y) is $400. Determine the values for the following: c. Consumption =

360

Suppose that the linear equation for consumption in a hypothetical economy is: C = 40 + 0.8Y Also suppose that income (Y) is $400. Determine the values for the following: e. Saving =

40

If a $50 billion initial increase in spending leads to a $250 billion change in real GDP, how big is the multiplier?

5.0

Suppose a family's consumption exceeds its disposable income. This means that its

APC is greater than one

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. Which of these factors might have caused this change?

C= 100 + 0.6y S= -100 + 0.4y an increase in the stock markets value

Linear equations for the consumption and saving schedules take the general form: C = a + bY 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 specific numerical values into the consumption and saving equations.

C= 80 + 0.6y S= -80 + 0.4y

1 + MPS = MPC.

False, MPC+MPS=1

Dissaving occurs when

Income is less than consumption

The simple multiplier 1/MPS

Overstates the actual multiplier because it excludes leakages in domestic spending from the purchase of imports or the paying of taxes

Which of the following would shift the saving schedule upward?

a decrease in wealth

The relationship between consumption and disposable income is such that

a direct and relatively stable relationship exists between consumption and income.

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 at least 20 percent; another $10 billion yielding at least 15 percent; another $10 billion yielding at least 10 percent; and so forth. a. Draw this relationship between the expected rate of return and the amount of investment expenditure. b. What will be the equilibrium level of aggregate investment if the real interest rate is as follows: 15%, 10%, 5%

a. 25 to 50 b. 20 billion, 30 billion, 40 billion

Suppose the wealth effect is such that $10 changes in wealth produce $1 changes in consumption at each level of income. Assume real estate prices tumble such that wealth declines by $80. a. What will be the new level of consumption at the $340 billion level of disposable income? b. What will be the new level of saving?

a. 316 b. 24

a. What will the multiplier be given the MPS values below? Fill in the table with your answers. b. What will the multiplier be given the MPC values below? Fill in the table with your answers. c. 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? How much of a change in GDP will result if firms increase their level of investment by $8 billion and the MPC instead is 0.67?

a. 0-undefined; 0.4-2.50; 0.5-1.67; 1-1 b. 1-undefined; 0.9-10; 0.75-4; 0.5-2; 0-1 c. 40 billion 24 billion

Suppose that an initial $10 billion increase in investment spending expands GDP by $10 billion in the first round of the multiplier process. Also suppose that GDP and consumption both rise by $6 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 $8 billion in the second round, what would have been the size of the multiplier?

a. 0.6 b. 2.5 c. 5.0

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? Will it invest in the machine if the real interest rate is 9 percent? If it is 11 percent?

a. 10% b. yes, yes, no

e. What is the term that economists use for the saving situation shown at the $240 level of income?

dissaving

Refer to the table below 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. a. Assuming no change in the real interest rate, by how much and in what direction will investment change? b.Which of the following might cause this change?

a. investment will decrease by 5 billion the investment schedule will shift to the left b. an increase in excess production capacity

A downshift of the consumption schedule typically involves an equal upshift of the saving schedule except when there is

an increase in personal taxes; then they both shift downward.

b. What is the economic meaning of b? What is the economic meaning of (1 - b)?

b is MPC (1-b) is MPS

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? a. Consumption schedule

consumption, disposable income, directly

During the Great Recession of 2007-2009, real interest rates

declined to about zero, and investments also declined sharply.

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? c. 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?

real gdp and disposable income are higher

If households consume less at each level of disposable income, they are

saving more

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? b. Saving schedule

saving, disposable income, directly

Data for output (real income) and saving are presented in the table below. a. Fill in the missing numbers (gray-shaded cells) in the table.

screenshot on desktop

The wealth effect is shown graphically as a

shift of the consumption schedule.

If businesses feel more optimistic about the state of the economy, then this change is likely to

shift the investment demand curve to the right.

The greater is the marginal propensity to consume, the

smaller is the marginal propensity to save

The APC can be defined as the fraction of a

specific level of total income that is consumed.

Which of the following scenarios will shift the investment demand curve right? Business taxes increase. The expected return on capital increases. Firms have a lot of unused production capacity. Firms are planning on increasing their inventories.

the expected return on capital increases firms are planning on increasing their inventories

The most important determinant of consumer spending is

the level of income

Art Buchwald's article in the Last Word section of the chapter, "Squaring the Economic Circle," is a humorous description of

the multiplier effect

The MPC for an economy is

the slope of the consumption schedule or line.

An increase in taxes will shift both the consumption schedule and the saving schedule down.

true

In what direction will each of the following occurrences shift the consumption and saving schedules, other things equal? d. A substantial increase in household borrowing to finance auto purchases.

upward; downward

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?

yes