Econ Exam 2
formula for the investment multiplier
1/ (1-b)
assuming there is no government involvement, the formula for the multiplier is
1/(1-MPC)
the value of the multiplier is
1/(1-MPC) OR 1/MPS
So therefore, the value of the multiplier is
1/(1-b)
in the relationship between Y* and I, the value of the planned investment, I is multiplied by
1/(1-b)
if I increases by unit, then Y* will increase by
1/(1-b) unit
assuming no government or foreign sector, if the MPC is 0.9, the multiplier is
10 (1/1-.9)
assume there is no government or foreign sector. if the multiplier is 10, a $10 billion increase in planned investment will cause aggregate output to increase by
100 billion
assume there is no leakage from the banking system and that all commercial banks are loaned up. the required reserve ratio is 12.5%. If the fed buys $20 million worth of government securities from the public, the change in money supply will be
$160 million (1/.125)*20
sources of structural deficit: revenue side
- the volume of tax revenue depends on the tax rates set by the government - since the 1980s, the US economy witnessed a decline in the tax rate
assume there is no leakage from the banking system and that all commercial banks are loaned up. the required reserve ratio is 10%. if the fed buys $10 million worth of government securities from the public, the change in the money supply will be
100 million (1/.10)*10
the federal reserve system consists of ________ federal reserve banks
12
the money multiplier is 8, the required reserve ratio is
12.5%
if C = 300 + 0.75Y and I = 200, then the equilibrium level of income is
2,000
If Logan received a $2,500 bonus and his MPS is 0.2, his consumption rises by _____ and his savings rises by _____
2,000, 500
the required reserve ratio is 5%, the money multiplier is
20
the Bank of Mesquite has $2 million in deposits and $550,000 in reserves. If excess reserves are equal to $150,000, the required reserve ratio is
20%
assume there is no government or foreign sector, if the MPS is 0.2, a $40 billion decrease in planned investment will cause aggregate output to decrease by
200 billion (1/.2 = 5 --> 40*5 = 200
If the MPC is 0.75, the government spending multiplier is
4 (1/(1-0.75)
Midwest state university in Nebraska is trying to convince Nebraska taxpayers that the tax dollars spent at MSU are well spent. One of the university's arguments is that for every $1 spent b MSU an additional $5 of expenditures are generated within Nebraska. MSU is arguing that the multiplier for their expenditures is
5
government spending increases by $40 billion and the equilibrium level of output increases by $200 billion. The government spending multiplier is
5
the aggregate consumption function is C = 100 + 0.6Y. if the income is $1,000 and net taxes are $300, consumption equals
520
If Earl received an $800 bonus and his MPS is 0.25, his consumption rises by $________ and his saving rises by $________.
600, 200
if C = 100 + 0.8Y and I = 50, then the equilibrium level of income is
750
If C = 1,500 + 0.75Y and I = 500, then planned saving equals planned investment at aggregate output level of
8,000
determinants of planned consumption expenditure (Cp)
1. interest rates- lower interest rates reduce the cost of borrowing, which encourages people to spend more 2. Wealth- higher wealth is associated with higher consumption 3. consumer confidence- which is measured by the consumer confidence index (CCI), gauges consumers' feelings about current and future economic conditions 4. income- single most important factor driving consumption
the current deficit
1.1 trillion
autonomous consumption
even when income is zero, people still have to consume (intersection of Y axis or consumption) on graph
when the interest rate rises, bond values
fall
defense spending is the largest part of the U.S. government spending (true/false)
false
Structural deficit
federal revenues at full-employment minus expenditures at full-employment under prevailing fiscal policy
if Y > PAE,
firms will be in a position where they have clearly produced too much. they will find that their inventories are increasing
if Y < PAE
firms will be in a position where they running out of their planned inventory. Therefore, they will increase production
by whom is the investment activities done by
firms: expanding factory, buying new buildings, etc.
four sectors of the economy
household firm government res of the world sector
As the MPS decreases, the multiplier will
increase
if the government wants to reduce unemployment, government purchases should be _______ and/or taxes should be _______
increased; decreased
during recession, government spending usually
increases because unemployment payments decrease
disposable income
increases when income increases
what determines the cost of borrowing?
interest rates
as income increases, what happens to consumption?
it increases also
when you pay $8 for salad you ordered for lunch, you are using money as an
medium of exchange
the multiple by which total deposits can increase for every dollar increase in reserves is the
money multiplier
what is the relationship between interest rates and planned investment? (positive or negative)
negative relationship
the demand for money and the interest rate are
negatively related
New Planned aggregate expenditure function
new PAE is obtained by shifting up new consumption function twice by the amount I and G
what are the largest sources of revenue for the federal government?
personal income taxes and payroll taxes
what is the largest source of revenue in the government's budget?
personal taxes
in macroeconomics, equilibrium is defined as that point at which
planned aggregate expenditure equals aggregate output
The President of Vulcan hires you as an economic consultant. He is concerned that the output level in Vulcan is too high and that this will cause prices to rise. He feels that it is necessary to reduce output by $10 billion. He tells you that the MPC in Vulcan is 0.6. Which of the following would be the best advice to give to the Vulcan president?
reduce government purchases $4 billion
debt to GDP ratios have ______ in the US and major European countries since 2006
risen
in the US health care costs are (rising or falling)
rising
a decrease in lump-sum taxes will
shift the consumption function upward
If the economy's full-employment output is $9 trillion, and the budget deficit is $20 billion, the deficit in this case is known as a
structural deficit
the change in savings divided by the change in income is equal to
the MPS
The MPC is
the change in consumption divided by the change in income
The MPS is
the change in saving divided by the change in income
Which of the following instruments is NOT used by the federal reserve to change the money supply?
the federal tax code
the discount rate is
the interest rate the fed charges commercial banks for borrowing money
comparison between old and new consumption function
the new consumption function is a downward shift of the old consumption function by the amount b*T
if the fed lowers the interest rate,
the planned investment is going to go up, which also results in the equilibrium to go up
which of the following is an investment
the purchase of a new printing press by a business
the government purchase multiplier is
the ratio of change in the equilibrium level of output to a change in government purchases
tax multiplier
the ratio of the change in the equilibrium level of output in taxes tells us about by how many units equilibrium income/output will change in an economy if taxes changes by one unit -MPC/(1-MPC)
the tax multiplier
the ratio of the change in the equilibrium level of output to the change in taxes
planned aggregate expenditure function
the relationship between PAE and Y - it is an upward shift of the consumption function by the amount of planned investment
What is the MPC (Marginal Propensity to Consume)?
the slope of the consumption function - the increase in consumption that takes place when we increase income by $1
fiscal policy refers to
the spending and taxing policies used by the government to influence the economy
aggregate income
the total income received by all factors of production in a given period
aggregate output
the total quantity of goods and services produced (or supplied) in a given period
disposable income =
total income - taxes Yd = Y-T
what is the largest expenditure source in the government budget?
transfer payments
what are the items that the government spends most on?
transfer payments and social insurance payments(social security, medicare, medicaid, etc)
If the MPS is .1, then the multiplier is 10
true
firms' investments include inventories
true
planned aggregate expenditure equals consumption plus planned investment
true
which of the following is a correct sequence of events during a recession?
unemployment rises, income falls, tax revenue falls, unemployment benefits rise and the budge deficit rises
when the manager of a department store attaches price tags to his/her products, he/she is using money as a
unit of account
the equilibrium
Y = PAE
which of the following represents an action by the federal reserve that is designed to increase the money supply?
a decrease in the required reserve ratio
If the Fed sells government securities, then there is
a decrease in the supply of money
social security
a social insurance program officially called "old-age survivors, and disability insurance" (OASDI) - primarily funded through a dedicated payroll tax of 12.4%
The voting members of the Federal Open Market Committee are
all of the members of the Board of governors and five of the presidents of the 12 federal reserve banks
which of the following will mostly likely cause a decrease in the quantity of money demanded?
an increase in the interest rate
why is the slope of the consumption function is less than 1?
because if your income goes up by $x, you're going to raise your consumption by less than $x
short-term securities are usually called ______ and long-term securities are usually called _______
bills; bonds
if interest rates are high,
borrowing costs are high, so want to borrow less
if interest rates are low,
borrowing costs are low, so want to borrow more
the fed uses open market operations to
buy or sell government securities
why current and projected higher spending on healthcare programs?
by 2035, adults who are "typical retirement age" are projected to outnumber children (under age of 18)
the Fed
clears inter-bank payments
assume that all commercial banks are loaned up. total deposits in the banking system are $200 million. the required reserve ratio is increases. the money supply will
decrease
Higher interest rates are likely to
decrease consumer spending and increase consumer saving
an open-market sale of securities by the Fed results in _______ in reserves and ________ in the supply of money
decrease; a decrease
if the government spending multiplier is 5 and government spending decreases by $200, output will ________ by $_________ billion
decreases; 1,000
historically, the federal budget runs on a (surplus or deficit)
deficit
a commercial bank lists
deposits as liabilities
what does planned consumption depend on?
disposable income (Y - T)
when income (Y) is high,
Cp < Y
when income (Y) is low
Cp > Y
if S = -200 + 0.2Y and I = 100, then the equilibrium level of income is
1,500
Bill's income is $1,000 and his net taxes are $350. His disposable income is
$650
suppose the required reserve ratio is 15%. A $10 million deposit will, at most, allow an expansion of the money supply to
$66.7 million
adding: -Government purchases or expenditures - taxes and disposable income
(G) adding to the equation (T) taxes (Yd) disposable income
firms borrow money from the markets to finance their investments borrowing takes place in a number of forms:
- bank borrowing - borrowing by issuing bonds - borrowing by issuing stocks
alternative representation of equilibrium
- economy equilibrium when Y = Cp + Ip = PAE -can rewrite that as Y - Cp = Ip not that Y-Cp = Sp therfore, Sp = Ip
during good times, the economy:
- economy produces more. as a result, more income is generated - more income leads to more tax revenue - there is less need to offer social insurance and assistance (e.g. unemployment benefits) - collectively, revenue increases and expenditure decreases resulting in a smaller deficits or even surpluses
what is so special about equilibrium income/output?
- the economy always has a tendency to converge toward equilibrium income/output - knowing this, economic policies are designed to alter the course of an economy by changing the level of equilibrium income/output
Government Expenditure multiplier
- the ratio of change in the equilibrium level of output to a change in government spending - tells us by how many units equilibrium income/output will change in an economy if the government expenditure changes by one unit 1/ (1-MPC)
if the MPC is 0.5, the tax multiplier is
-1 --> (.5/1-.5)
if the MPC is 0.7, the tax multiplier is
-2.33
taxes are reduced by $15 billion and income increases by $75 billion. the value of the tax multiplier is
-5
Federal Debt
-US government needs to borrow when it runs on deficits -US government needs to issue treasury bonds to finance deficit -Federal Debt is the accumulated deficits -US government needs to pay interest on the accumulated debt
sources of deficit on expenditure side:
-costs of healthcare programs -costs of social security programs -costs of interest payments
during bad times in the economy:
-economy produces less. as a result, less income is generated - low level of income leaders to lower tax revenue for the government - there is more need to offer social insurance and assistance -collectively revenue decreases and expenditure increases resulting in larger deficits
planned investment expenditure: firm's decision variables to invest
-market size and future profitability - uncertainty - tax incentives - market interest rate- most important
balanced budget multiplier
-suppose that G increases by one unit - at the same time T increases by one unit - no change in the budget deficit or surplus question: what effect will it have on the equilibrium income/output? Net Effect: (1-b)/(1-b) = 1 conclusion: Y* will increase by 1 unit so, value of balanced budget multiplier = 1
investment multiplier
-the ratio of the change in the equilibrium level of output to a change in planned investment - it measures how much an equilibrium income/output will change as a result of a change in the planned investment by one unit
If the MPS is 0.6 the MPC is
0.4
If the consumption function is in the form [ C = 80 +0.4Y], the MPS equals
0.6
If consumption is $30,000 when income is $35,000, and consumption increases to $36,000 when income increases to $43,000, the MPC is
0.75
assuming there is no government or foreign sector, if the multiplier is 10, MPC is
0.9
aggregate demand for goods and services
Cp + Ip + G + (Xp - IMp) consumption + investment + government + (exports - imports)
After government is added to the income-expenditure model, the formula for the aggregate consumption function is
C = a + b(Y-T)
New consumption function formula
C = a + b(Yd) C = a + b(Y-T)
consumption function general equation
C = a + bY a = constant (autonomous consumption) b = slope (MPC) Y = income C = consumption
which country hold the most of US debt?
China domestically, individuals hold the most debt
the central bank of the united states is known as the
Federal reserve system
assuming there is no foreign trade in the economy, the economy is in equilibrium when
I + G = S + T
MPC + MPS =
MPC + MPS = 1
New Planned Aggregate Expenditure (Aggregate Demand)
PAE = Cp + Ip + G Cp (household sector) Ip (Firm Sector) G (government sector)
planned aggregate expenditure
PAE = Cp+ Ip = Cp + I the aggregate demand for goods and services
planned savings function
Sp = Y - Cp slope (MPS)