Chapter 5

5.2.3 An increase in consumer income will cause the consumption function to shift outward. Select one: True False

False Consumption is a function of income. If a factor other than income changes, the consumption function will shift. The correct answer is 'False'.

5.2.5 If businesses predict an upcoming recession, they will increase their investments. Select one: True False

False If the economy is expected to fall into a recession, businesses will cut back on their investments because of decreasing profit opportunities during a recession.

5.5.1 Keynes believed government could do nothing to stimulate the economy during recessionary times or to slow down the economy during inflationary times. Select one: True False

False Keynes in fact believed that expansionary fiscal policy (increased government spending) can pull an economy out of a recession, and contractionary fiscal policy (reduced government spending) can slow down an inflationary economy.

5.1.1 When prices and wages did not adjust to equilibrium during the Great Depression as classical economists predicted, John Maynard Keynes proposed increasing the supply of loanable funds to remedy the Depression. Select one: True False

False Keynes proposed stimulating demand and spending to force adjustments to equilibrium.

5.6.1 The aggregate demand/aggregate supply model relates the effects of changing prices on the components of the Keynesian model. Select one: True False

True The Keynesian model ignores price changes and their effects on real GDP. When we consider the increases and decreases in spending that result from falling and rising prices, we can construct the aggregate demand curve, which shows the inverse relationship between prices and output.

5.3.1 Because savings are a leakage out of the circular flow model, the only way to maintain balance is the borrowing of savings by businesses for investment. Select one: True False

True To maintain the balance of the circular flow, leakages must equal injections. Savings are a leakage, but investment spending is an injection back into the flow. When businesses borrow consumer savings and purchase capital goods, balance in the circular flow is restored.

5.2.2 Assuming taxes equal zero, if the average propensity to consume = .9, we can conclude that consumers typically save 10% of their total income. Select one: True False

True When taxes equal zero, total consumer income is either spent or saved. If APC = .9, the average propensity to save must equal .1. We can conclude that consumers save 10% of their total income.

5.3.1 When income is above equilibrium, Select one: a. the marginal propensity to consume will decrease. b. excess consumer demand arises. c. unintended inventory accumulation causes businesses to cut back production. d. the marginal propensity to save will increase.

Unintended inventory accumulation is the result of businesses producing too much and consumers buying too little. Balance is disrupted as the income level rises above equilibrium. Businesses must cut back production until equilibrium is reached.

5.5.1 When the equilibrium level of output in the economy is greater than the full-employment level, the economy is said to have Select one: a. a recessionary gap. b. an inflationary gap. c. excess demand. d. excess supply.

b. In the long run, the economy cannot produce more than the full-employment level of output. If it tries to do so, prices rise, causing what is known as an inflationary gap.

5.5.3 If the value of the U.S. dollar rises relative to the French franc, Select one: a. the U.S. dollar would buy fewer francs. b. French imports into the U.S. rise. c. U.S. exports to France rise. d. U.S. imports and exports are unaffected.

b. In this example, the exchange rate has risen. Americans are able to purchase more French francs per U.S. dollar. French goods and services are more attractive to Americans, and the U.S. imports more French goods.

5.3.1 Suppose the linear consumption funtion is C = 15 + 0.8Y. Using the savings approach, what is the y-intercept of the savings function? Select one: a. 15 b. −15 c. 0.2 d. There is not enough information to determine the y-intercept of the savings function.

b. In this example, the y-intercept of the consumption function is 15. According to the savings / investment approach, the y-intercept of the savings function is the negative value of the y-intercept of the consumption function. In this example, the y-intercept of the savings function is −15.

5.5.1 Which of the following policy measures would help close a recessionary gap? Select one: a. An increase in the rate of savings b. An increase in government spending c. A decrease in government spending d. A decrease in the marginal propensity to consume

b. Increasing government spending would increase output by the amount of the autonomous increase in spending times the multiplier, helping move the economy toward the full-employment level of output and out of a recession.

5.2.2 The fraction of each additional dollar of income spent defines which of the following terms? Select one: a. Average propensity to consume (APC) b. Average propensity to save (APS) c. Marginal propensity to consume (MPC) d. Marginal propensity to save (MPS)

c. The marginal propensity to consume (MPC) is the fraction of each additional dollar of income spent. For example, if MPC = .8, consumers will typically spend $.80 of each additional $1.00 of income they receive.

5.2.2 The change in savings that results from a change in income represents the Select one: a. marginal propensity to consume. b. average propensity to consume. c. marginal propensity to save. d. average propensity to save.

c. The marginal propensity to save is the change in savings that results from a change in income. If MPS = .3, for example, consumers will typically save $.30 of each additional $1.00 of income they receive.

5.1.1 Classical economists argued that the Great Depression would eventually end when output returned to the full employment level with no help from the government. Select one: True False

true Classical economists believed that the economy was self-regulating and that it would return to the full employment level in the long run. Although Keynes and others agreed with this proposition, they questioned the classical economists' notion of the length of the short run.

5.2.1 In the aggregate expenditure identity, the equilibrium condition is that Select one: a. aggregate expenditure equals planned spending. b. aggregate expenditure equals output. c. consumption plus investment equals government spending plus output. d. consumption equals aggregate expenditures.

B. The equilibrium condition is that aggregate expenditures equal output. The equation Y = C + I + G + NX is always true in equilibrium so it is an identity.

5.1.1 According to Say's Law, supply creates demand. Select one: True False

True French economist J.B. Say stated that the income payments received by producers would equal the value of the goods they produced. Therefore, demand always equals the amount of goods produced.

5.5.3 What effect does a depreciation in the dollar have on net exports by the United States? Select one: a. It increases net exports, increasing output. b. It increases net exports, reducing output. c. It decreases net exports, increasing output. d. It decreases net exports, reducing output.

a. A depreciation of the dollar means that fewer units of foreign currency are needed to purchase a dollar. The weakening of the dollar makes U.S. goods and services less expensive, increasing net exports and output (Y = C + I + G + NX).

5.2.2 If the marginal propensity to consume = .85 and taxes = 0, we know that consumers typically save $.15 of each additional dollar of income they receive. Select one: True False

True Assuming taxes equal zero, total consumer income is either spent or saved. If MPC = .85, MPS = .15. So consumers will save $.15 of each additional dollar of income they receive.

5.2.5 Business spending, or investment, is an injection into the circular flow model. Select one: True False

True In Keynes's demand-driven model of the macroeconomy, the spending of consumers, businesses, government, and foreigners are injections into the circular flow.

5.2.3 An increase in autonomous spending will shift the aggregate expenditures (AE) line upward. Select one: True False

True Increasing an autonomous spending component (a, I, G, NX) will move the y-intercept upward and shift the AE line. When a factor other than income changes, the AE line shifts. The correct answer is 'True'.

5.5.2 What happens if the government increases taxes without increasing spending? Select one: a. Aggregate demand falls, and output declines. b. Aggregate demand falls, and output rises. c. Aggregate demand rises, and output rises. d. Aggregate demand rises, and output declines.

a. An increase in taxes is a leakage from the system, because it means that households have less money to spend on consumption. If the government simply kept the money, aggregate demand would decline because of the drop in consumption. As a result of the inward shift of the aggregate demand curve, the level of output would decline.

5.7.1 Which of the following would cause output to rise if the economy were operating below the full-employment level of output? Select one: a. An increase in the marginal propensity to consume b. A decrease in the marginal propensity to consume c. A decrease in government spending d. An increase in savings

a. An increase in the marginal propensity to consume would increase the effect on output of a change in autonomous spending by increasing the size of the multiplier.

5.2.2 If autonomous spending = $10, Select one: a. the y-intercept of the savings function will be −$10. b. the consumer will contribute to savings if income equals zero. c. the slope of the savings function will be 10. d. the consumer will spend $.90 of each additional dollar of income received.

a. Autonomous spending is the y-intercept of the linear consumption function. The y-intercept of the savings function equals −10. When income is zero, consumers will draw an amount equal to autonomous spending from their savings.

5.3.1 In a simple model where aggregate expenditures (AE) are comprised only of consumption and investment, the intersection of the AE line and the 45-degree line is Select one: a. above the point where savings equals zero. b. equal to the point where consumer spending equals income. c. below the point where savings equals zero. d. equal to the point where savings equals zero.

a. Equilibrium must be at a point where consumers are saving. The AE line will shift up with the introduction of investment spending, and the new equilibrium will be at a higher level of income, consumption, and savings.

5.5.1 Suppose the government provides an extra incentive for consumers to save. What do you predict will happen? Select one: a. The slope of the AE line will flatten. b. The marginal propensity to consume will increase. c. The aggregate expenditures (AE) line will shift upward. d. Equilibrium output will increase.

a. Extra incentives to save cause an increase in the marginal propensity to save and a decrease in the marginal propensity to consume. Recall that the slope of the AE line is the marginal propensity to consume. A decrease in the slope of the AE line will cause the line to flatten.

5.7.1 How does the household savings rate affect the impact on output of an increase in government spending? Select one: a. If the rate of savings is low, the effect of the increase will be greater than it otherwise would have been. Correct b. If the rate of savings is high, the effect of the increase will be greater than it otherwise would have been. c. If the increase in government spending is high, the effect will be large. d. It has no effect.

a. If the rate of savings is low, the marginal propensity to consume and the multiplier are high. The effect of an increase in autonomous spending would thus be larger than it otherwise would have been.

5.5.2 An increase in taxes reduces aggregate expenditures by an amount equal to Select one: a. the change in taxes multiplied by −b. b. the change in taxes multiplied by (−b/1 − b). c. the change in taxes multiplied by (1/1 − b). d. the change in taxes.

a. Increasing taxes affects aggregate expenditures, because the increase reduces disposable income (Y − T). We can calculate the reduction in aggregate expenditures by multiplying the change in taxes by −b.

5.1.1 Keynes's model of a demand-driven economy ignores the effects of Select one: a. inflation and supply shocks. b. government spending and output. c. unemployment and low wages. d. tax incentives and tax cuts.

a. Keynes is quoted as having said, "In the long run, we are all dead." His short-run model of the economy employs expansionary fiscal policy to pull an economy out of a recession. In doing so, prices and output increase and can lead to inflation in the long run or an increase in the price of resource inputs.

5.2.1 ccording to Keynes, consumption is a function of Select one: a. real GDP. b. the real interest rate. c. the aggregate price level. d. the marginal propensity to consume.

a. On the graph of the consumption function, consumption is placed on the vertical axis, and real GDP—or income—is placed on the horizontal axis. When income changes, consumption also changes. Remember that Keynes's macroeconomic equilibrium dictates that spending must equal income.

5.6.1 According to the aggregate demand/aggregate supply curve, when prices rise, Select one: a. businesses will cut back spending. b. businesses will increase spending by the amount of the price increase. c. businesses will increase spending by an amount less than the price increase. d. business spending is unaffected.

a. People will increase their demand for money when prices increase. When the demand for money increases, the interest rate (the cost of borrowing money) will increase. Remember the inverse relationship between the interest rate and the quantity of investment. A high interest rate deters business spending, while a low interest rate induces business spending.

5.2.5 When investment is added to the consumption function, Select one: a. the y-intercept shifts upward. b. the slope increases. c. the y-intercept shifts upward, and the slope increses. d. the slope decreases.

a. The graph below illustrates the addition of investment spending to the consumption function. We can see that the slope of the line (MPC) remained the same, while the y-intercept shifted upward. - line shifts if anything other than interest rate is changed

5.2.3 According to Keynes's aggregate expenditures model, macroeconomic equilibrium occurs when Select one: a. aggregate expenditures equal income. b. the money supply equals aggregate expenditures. c. aggregate expenditures equal aggregate supply. d. aggregate demand equals aggregate expenditures.

a. The graph below shows the intersection of the aggregate expenditures line and the 45-degree line. Point A illustrates the macroeconomic equilibrium that occurs when spending equals income.

5.2.1 Given the linear consumption function C = 20 + 0.9Y, the y-intercept is ______. Select one: a. 20 b. 0.9 c. Y d. indeterminate

a. The linear consumption function is written as C = a + bY, where a is autonomous spending (the y-intercept), b is the marginal propensity to consume (the slope), and Y is income (the constant variable).

5.5.1 A shift in the aggregate expenditures (AE) line causes Select one: a. a change in equilibrium GDP larger than the shift of the AE line. b. a change in equilibrium GDP smaller than the shift of the AE line. c. a change in equilibrium GDP equal to the shift of the AE line. d. no change in equilibrium GDP.

a. The multiplier effect occurs when a small change in autonomous spending causes a huge change in equilibrium output, or real GDP.

5.4.1 Which of the following statements about the multiplier is true? Select one: a. The higher the marginal propensity to consume, the larger the multiplier. b. The lower the marginal propensity to consume, the larger the multiplier. c. The smaller the multiplier, the more output rises as a result of increases in autonomous spending or investment. d. None of the above are true.

a. The multiplier is determined by the formula Y = (1/1 − b) (a + I). If the marginal propensity to consume (b) is large, the multiplier will be large, and increases in autonomous spending and investment will generate large increases in output.

5.2.2 Which of the following statements regarding the marginal propensity to consume (MPC) is correct? Select one: a. Assuming taxes = 0, MPC = 1 − the marginal propensity to save (MPS). b. MPC is the fraction of each additional dollar of income that consumers save. c. MPC is the fraction of each additional dollar of income that is not spent on taxes. d. MPC represents the y-intercept of the linear consumption function.

a. Three uses of consumer income are spending, saving, or paying taxes. If taxes = 0, MPC + MPS = 1. So MPC = 1 − MPS.

5.4.1 If the marginal propensity to consume is 0.9, what happens to GDP if you dip into your savings to buy a $2,000 stereo system? Select one: a. Autonomous spending increases by $1,800, and GDP rises by $18,000. b. Autonomous spending increases by $2,000, and GDP rises by $20,000. c. Autonomous spending increases by $1,800, but GDP remains unchanged. d. Autonomous spending increases by $2,000, but GDP remains unchanged.

b. Autonomous spending is the initial increase in spending. In this example, the $2,000 is the increase in autonomous spending. If the marginal propensity to consume is 0.9, the owner of the stereo store spends 90% of what he earns on the sale of the stereo, or $1,800. The incomes of the people from whom he buys things will increase their consumption, and so forth and so on. Output will rise by 1/1 − b (or 10) times the initial increase in spending.

5.2.3 Taxes Select one: a. are an injection into the circular flow model. b. decrease disposable income. c. are government expenditures. d. increase consumer savings.

b. Disposable income = Y − T, consumer income after taxes. An increase in taxes will decrease disposable income. The correct answer is: decrease disposable income.

5.3.1 Which of the following is not a source of savings in an economy? Select one: a. Household savings b. Government spending c. Budget surplus d. Trade deficit

b. Government spending is not a source of savings. An excess of tax revenue over government spending (a budget surplus) provides savings that in turn become available to business for capital investments.

5.2.1 Which of the following describes the macroeconomic equilibrium? Select one: a. Total output > total spending b. Total spending = total output c. Y > C + I + G + (X − M) d. S > I

b. In equilibrium, output and spending are always equal. The economy cannot be in equilibrium when either side of the identity is greater than the other or when saving (S) does not equal investment (I).

5.1.1 John Maynard Keynes, during the Great Depression in the 1930s, wrote that economies experiencing high unemployment should follow policies that Select one: a. increase aggregate supply. b. increase aggregate demand. c. reduce net exports. d. balance the Federal budget.

b. Keynes believed that the problems with the economy were due to a lack of spending, or lack of demand. Therefore, he focused on the demand side of the economy and advocated programs that would increase aggregate demand. The most popular method to increase spending was to increase government spending and / or lower taxes.

5.2.1 When graphing Keynes's consumption function, we place __________ on the horizontal axis and __________ on the vertical axis. Select one: a. consumption; income b. real GDP; consumption Correct c. the real interest rate; consumption d. consumption; wages

b. Real GDP, or income, is placed on the horizontal axis, and consumption, or consumer spending, is placed on the vertical axis. Remember that the vertical intercept is autonomous spending, and the slope is the marginal propensity to consume.The interest rate determines the cost of borrowing money. Therefore, if the cost of borrowing money decreases, businesses will find that investments are more profitable and increase their spending.

5.6.1 What would happen if the government increased its spending in response to an increase in consumer savings? Select one: a. The increase in government spending would cause output to rise by even more than it would as a result of the increase in savings. b. The increase in government spending would offset (fully or partially) the decline in consumer spending. Correct c. The increase in government spending would cause investment spending to fall, causing output to decline. d. None of the above.

b. Savings represent a leakage from the system, which causes the size of the economy to contract. The government could counteract that contraction by increasing its own spending, which represents an injection into the system.

5.1.1 If an economy is experiencing a(n) __________, Keynes would propose to __________ consumer demand by implementing ___________ fiscal policy. Select one: a. recession; contract; contractionary b. recession; stimulate; expansionary c. expansion; stimulate; contractionary d. expansion; contract; expansionary

b. The Keynesian model dictates the implementation of expansionary fiscal policy (increasing government spending or decreasing taxes) to stimulate consumer demand and lead an economy out of a recession.

5.6.1 Which of the following identifies a problem with the Keynesian model? Select one: a. The model only illustrates long-term effects on the economy. b. The model ignores the effects of price changes on income, or real GDP. c. The model does not illustrate leakages and injections. d. The model only studies the supply side of the economy.

b. The Keynesian model holds prices constant and explores the effects of rising and falling demand.

5.2.5 When interest rates rise, we can predict that businesses will Select one: a. increase their quantity invested. b. decrease their quantity invested. Correct c. invest more at any given interest rate. d. invest less at any given interest rate.

b. The downward-sloping investment demand curve represents the inverse relationship between the interest rate and the quantity of funds demanded for investment. Changes in the interest rate cause movements along the curve. Changes in factors other than the interest rate cause shifts in the curve.

5.2.1 Given the linear consumption function C = 20 + 0.9Y, the slope of the line is ______. Select one: a. 20 b. 0.9 c. Y d. indeterminate

b. The linear consumption function is written as C = a + bY, where a is autonomous spending (the y-intercept), b is the marginal propensity to consume (the slope), and Y is income (the constant variable).

5.2.2 If a household's disposable income increases from $80,000 to $87,500 and their consumption increases from $60,000 to $66,000, the Select one: a. household is drawing from savings. b. slope of the savings function is .2. c. slope of the consumption function is .2. d. slope of the consumption function is .5.

b. The marginal propensity to consume is the change in consumption that results from a change in income. Divide: ($60,000 − $66,000) / ($80,000 − $87,500) = .8, the marginal propensity to consume. Because MPC + MPS = 1, the marginal propensity to save (the slope of the savings function) = .2.

5.7.1 Which of the following factors would increase the size of the multiplier? Select one: a. An increase in government spending b. An increase in the marginal propensity to consume c. An increase in investment spending d. None of the above; the multiplier is a constant.

b. The multiplier is determined by the marginal propensity to consume. If households spend 90% of their income, the multiplier is 1 / (1 − .9) = 10. If households spend just 50

5.5.2 Which of the following is the correct expression of the tax multiplier? Select one: a. 1 / (1 − b) b. −b / (1 − b) c. 1 / −b d. b / (−b + 1)

b. The tax multiplier is equal to −b / (1 − b).

5.5.1 What is the effect on output of an increase in government spending of $1 million, if the marginal propensity to consume is 0.8? Select one: a. $800,000 b. $5 million c. $8 million d. None of the above

b. Using the formula Y = 1 / (1 − b) [a + I + G + NX], an increase in autonomous spending of $1 million increases output by 1 / (1 − 0.8) [$1 million], or $5 million.

5.6.1 According to the aggregate demand/aggregate supply model, when prices rise, Select one: a. consumers will increase their spending. b. consumers will decrease their spending. c. consumers' purchasing powers increase. d. consumer spending is unaffected.

b. When prices rise and purchasing power decreases, consumers choose to decrease their spending. Consumers must spend more money to purchase the same basket of goods and services.

5.2.3 Which of the following statements regarding Keynes's aggregate expenditures (AE) model is correct? Select one: a. Imports are injections into the circular flow model. b. Taxes are leakages out of the circular flow model and reduce disposable income. Correct c. Businesses' investment spending is a leakage out of the circular flow model. d. To achieve macroeconomic equilibrium, injections must exceed leakages.

b. When the government imposes taxes, money leaks out of the circular flow. Taxes decrease disposable income as illustrated in the consumption function: C = a + b (Y − T). The correct answer is: Taxes are leakages out of the circular flow model and reduce disposable income.

5.5.3 Which of the following provides the savings with which businesses finance their investments? Select one: a. Household consumption b. The government budget deficit c. The trade deficit d. Exports

c. A trade deficit means that imports exceed exports. The difference between the two is financed by lending from foreigners, which businesses invest. To see why running a trade deficit implies that foreigners are lending to domestic businesses, consider what happens when you purchase a stereo system from Japan. You pay for the stereo in U.S. dollars, which the Japanese company exchanges at the Japanese central bank for yen. The Japanese central bank now holds U.S. dollars, which it may choose to deposit in a U.S. bank. The U.S. bank in which the Japanese central bank deposits its funds now has excess funds to lend to U.S. businesses.

5.6.1 According to Keynes, which of the following could have helped pull the United States out of the Great Depression? Select one: a. an increase in the savings rate b. an increase in taxes c. an increase in government spending d. an increase in interest rates

c. According to Keynes, increasing government spending on public goods creates demand, which in turn creates jobs and helps the economy expand out of a recession or depression.

5.2.3 Which of the following is not a component of aggregate expenditures? Select one: a. Consumption b. Investment c. Taxes d. Government spending

c. Aggregate expenditures = consumption (C) + investment (I) + government spending (G) + net exports (NX). These components are the spending plans of all individual sectors in the economy. The correct answer is: Taxes

5.5.2 How do households react to an increase in taxes? Select one: a. They reduce their consumption. b. They reduce their savings. c. They reduce both consumption and savings. d. None of the above

c. An increase in taxes represents a decrease in disposable income (the income households have to spend after taxes). In response to the decline, households reduce their consumption by the reduction in income times the marginal propensity to consume. Thus, if disposable income falls by $100 and the marginal propensity to consume is 0.8, household consumption falls by $80 and savings falls by $20.

5.2.5 Which of the following does not directly influence investment expenditures? Select one: a. Technological innovations b. Interest rates c. Marginal propensity to consume d. Unpredictable lives of capital goods

c. Because the marginal propensity to consume deals primarily with the spending of consumers, it does not directly influence investment expenditures.

5.7.1 Which of the following must be true if output rises by $400 million following an increase in government spending of $100 million? Select one: a. The marginal propensity to consume must be 4.0. b. The marginal propensity to consume must be 3.0. c. The marginal propensity to consume must be 0.75. d. The marginal propensity to consume must be .40.

c. If a $100 million change in autonomous spending generates an increase in output of $400 million, the multiplier must be equal to 4. If the multiplier is 4, the marginal propensity to consume must be 0.75, because the multiplier is equal to 1/1 − MPC.

5.2.2 If households saved each additional dollar of income they received, the slope of the consumption function would equal Select one: a. one. b. a positive number less than one. c. zero. d. a positive number greater than one.

c. If households saved each additional dollar of income they received, the marginal propensity to save would equal 1. The slope of the consumption function is MPC. If MPC + MPS = 1, and MPS = 1, then MPC = 0.

5.4.1 An increase in autonomous spending raises GDP by more than the original increase in spending, because Select one: a. households invest much of the money in savings instruments. b. households do not immediately recognize that their incomes have risen. c. individuals spend part of the money, increasing incomes of other individuals, who then spend part of their extra money. d. individuals spend all of the money they earn, causing businesses to increase investment.

c. Increases in autonomous spending raise GDP by more than the original increase in spending because of the multiplier effect. To see how this effect works, think about what happens if the state government decides to build a $10 million highway. It spends the money by hiring construction workers to build the road. These construction workers now have higher incomes, some of which they save and some of which they spend. When they spend the money, they increase the incomes of other workers, who save some of that money and spend some as well. This process continues to ripple through the economy, increasing output by much more than the original increase in spending.

5.5.3 Which of the following correctly expresses how savings equals investment? Select one: a. I = S + G + NX − T b. I = S (T − G) − NX c. I = S + (T − G) − NX d. I = C + S (T − G) + NX

c. Investment comes from consumer savings, a government budget surplus, and a foreign trade deficit.

5.5.2 Which of the following does not represent a leakage from household consumption? Select one: a. Savings b. Taxes c. Purchases d. None of the above

c. Purchases are consumption, not leakages from consumption.

5.4.1 If the marginal propensity to consume is 0.5, to how much will GDP increase if autonomous spending increases by $5 million? Select one: a. $2.5 million b. $5 million c. $10 million d. $25 million

c. Recall that Y = (1/1 − b) (a + I). Thus, if autonomous spending increases by $5 million, and the marginal propensity to consume is 0.5, GDP will increase to $10 million.

5.5.2 By how much does output increase if government spending and taxes rise by $20 million and the marginal propensity to consume is 0.75? Select one: a. There is no effect on output. b. $4 million c. $20 million d. $5 million

c. Study the illustration below. The balanced budget multiplier shows how much output rises if government spending and taxes rise by exactly the same amount. Because the increase in taxes reduces consumption by the amount of the tax increase times the marginal propensity to consume, and government spending increases aggregate demand by the full amount of the increase, output rises by the amount of the increase (in this case, $20 million).

5.5.3 How is it possible for the United States to import more than it exports? Select one: a. The U.S. government finances the difference between exports and imports. b. Private domestic investors finance the difference between exports and imports. c. Foreigners lend the U.S. the money to pay for the imports. d. International institutions, such as the World Bank and the International Monetary Fund, help the U.S. finance its imports.

c. The money comes from foreigners, who are willing to save in the U.S. To see how this works, consider what happens when you buy a BMW. To pay for your new car, you write your local dealer a check for $40,000, which he sends to the company's headquarters in Germany. BMW exchanges the $40,000 at the German central bank for an equivalent sum in Deutsch marks. The German central bank now holds $40,000 in U.S. dollars, which it can deposit in a U.S. bank.

5.4.1 Assume taxes = 0 and imports = 0. If the marginal propensity to consume = .5, the value of the multiplier is Select one: a. .5 b. 1 c. 2 d. 5

c. To calculate the multiplier: 1 / (1 − .5) = 2. When the marginal propensity to consume = .5, the change in an autonomous spending component will cause equilibrium GDP to double.

5.2.3 ___________ are leakages out of the circular flow model. Select one: a. Exports b. Government expenditures c. Taxes d. Business expenditures

c. When households pay money to the government in the form of taxes, money is taken out of the circular flow, and equilibrium is disrupted. The correct answer is: Taxes

5.2.5 When businesses decide to increase their investments, Select one: a. the marginal propensity to consume increases. b. the slope of the aggregate expenditures line steepens. c. equilibrium income rises. d. the aggregate expenditures line shifts downward.

c. When investment increases, aggregate expenditures increase. The upward shift of the aggregate expenditures line causes an increase in real GDP, or income.

5.5.3 Suppose the U.S. dollar strengthens relative to the German deutsche mark. Which of the following is most likely to occur? Select one: a. U.S. exports into Germany will increase. b. Foreign demand for domestic products will increase. c. German imports into the U.S. will increase. d. American goods will be relatively cheaper than German goods.

c. When the U.S. dollar strengthens relative to the German deutsche mark, Germans demand more marks to buy one U.S. dollar. Our goods become too expensive, while German goods appear to be a bargain to Americans. U.S. exports will decrease, and German imports will increase.

5.3.1 Assume that consumers are the only players in the economy. When income equals consumption, we can conclude that Select one: a. savings is less than zero. b. savings is greater than zero. c. savings is equal to zero. d. savings, income, and consumption are equal.

c.If we assume that the only players in the economy are consumers, and we know that their income equals their consumption, then consumers do not have anything left over to save. Savings in this economy equals zero.

5.5.3 Which of the following factors affects the demand for imports and exports? Select one: a. The exchange rate b. Income c. Preferences d. All of the above

d. All of the factors cited affect the demand for imports and exports. The exchange rate affects the price of a good in a foreign currency: a leather jacket from Italy that costs $250 when the dollar is worth 2,000 Italian lira, for example, costs $500 when the dollar falls to just 1,000 Italian lira. Income affects the demand for all goods, including imported goods. Preferences affect the demand for imports and exports.

5.5.3 If the level of imports remains constant and the marginal propensity to consume is 0.75, what happens to output when exports increase from $550 to $750 million? Select one: a. Output falls by $200 million. b. Output rises by $200 million. c. Output falls by $800 million. d. Output rises by $800 million.

d. An increase in net exports (the difference between exports and imports) increases output by an amount equal to the change in net exports times 1/1 − b, where b is the marginal propensity to consume.

5.6.1 Macroeconomic equilibrium can be expressed as Select one: a. savings = consumption. b. income = net exports. c. investment = government expenditures. d. leakages = injections.

d. In Keynes's circular flow model, leakages out of the circular flow must equal injections into the circular flow.

5.2.3 The Keynesian model of aggregate expenditures Select one: a. is driven by demand. b. represents macroeconomic equilibrium. c. can be illustrated by the circular flow model. d. all of the above.

d. Keynes's model of the macroeconomy is driven by demand. Keynes believed that all spending (planned spending) must equal income. When spending equals income, the economy is in equilibruim. The flow of money and resources that is the circular flow model is an illustration of the macroeconomic equilibrium. The correct answer is: all of the above.

5.2.5 When graphing the investment demand curve, we place _________ on the horizontal axis and _________ on the vertical axis. Select one: a. investment, aggregate price level b. income, investment c. investment, real GDP d. investment, interest rate

d. Looking at this graph we can see that investment lies on the horizontal axis and is a function of the interest rate, which is graphed on the vertical axis. Businesses invest more when the interest rate (the price of borrowing money) decreases, and businesses invest less when the interest rate rises.

5.6.1 Which of the following would cause output to fall as a result of an increase in the price level? Select one: a. Investment spending declines. b. Consumer spending falls. c. Exports decline d. All of the above.

d. Output declines as a result of all three factors. First, when prices rise, the demand for money increases, because people need to hold more money to pay for the higher-priced goods. The increase in the demand for money causes interest rates to rise, choking off investment and causing output to decline. Second, consumer spending declines, because of the shrinking purchase power of people's wealth. Third, exports decline, as foreigners become less interested in purchasing the country's goods, which are now more expensive than they were.

5.4.1 If income increases by $250 million as a result of a $50 million autonomous increase in investment spending, how large is the multiplier? Select one: a. $50 million b. $200 million c. 25 d. 5

d. The change in output ($250 million) divided by the change in investment spending ($50 million) equals 5. A multiplier of 5 means that the effect on output is five times as great as the increase in autonomous spending or investment. Correct

5.5.1 What determines the slope of the aggregate expenditures line? Select one: a. Government spending b. Business investment c. The difference between government revenue and government spending d. The marginal propensity to consume

d. The marginal propensity to consume (MPC) determines the slope of the aggregate expenditures line. The higher the MPC, the larger the multiplier and the larger the effect of changes in autonomous spending on output.

5.7.1 What is the effect on output of an increase in spending of $50 if the marginal propensity to consume is 0.8? Select one: a. $40 b. $50 c. $100 d. $250

d. The multiplier—the amount by which output rises as a result of a change in spending—is given by the formula 1/1 − MPC. If the marginal propensity to consume is 0.8, the multiplier is 1/1 − 0.8 = 1/0.2 = 5. The product of the multiplier and the increase in spending is $250.

5.4.1 Suppose that investment spending increases by $4.5 billion, and the slope of the aggregate expenditures (AE) line is .75. What is the change in the equilibrium level of real GDP? Select one: a. $1.125 billion b. $3.375 billion c. $6 billion d. $18 billion

d. To calculate the change in equilibrium GDP: $4.5 billion × (1 / (1 − .75)) = $4.5 billion × (1/.25) = $4.5 billion × 4 = $18 million.

5.5.2 If the slope of the aggregate expenditures line (AE) is .8 and taxes increase by $5, what is the change in equilibrium income? Assume government spending equals 0. Select one: a. $4 decrease in equilibrium income b. $4 increase in equilibrium income c. $5 increase in equilibrium income d. $20 decrease in equilibrium income

d. To calculate the change in equilibrium income: −.8 / (1 − .8) = −4. Multiply −4 by the change in taxes (5) to calculate a $20 decrease in equilibrium income.

5.4.1 If a $6 billion increase in investment spending causes a $30 billion increase in equilibrium real GDP, the slope of the aggregate expenditures (AE) line equals ______. Select one: a. .2 b. .3 c. .5 d. .8

d. To calculate the slope of the AE line: $30 billion / $6 billion = 5, the multiplier. If the multiplier = 5, the marginal propensity to consume (the slope of the AE line) = .8. 1 / (1 − .8) = 5.

5.2.2 Suppose your total consumption = $800, and your total income = $1,000, your average propensity to consume is _____. Select one: a. 800 b. 80 c. 8 d. .8

d. To calculate your average propensity to consume: $800 / $1,000 = .8. The average propensity to consume is the total overall consumption as a fraction of total income.