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27 Expenditure Multipliers Answers to the Review Quizzes

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James Moore
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27 Expenditure Multipliers Answers to the Review Quizzes

1. Which components of aggregate expenditure are influenced by real GDP?

2. Define and explain how we calculate the marginal propensity to consume and the
marginal propensity to save.
3. How do we calculate the effects of real GDP on consumption expenditure and
imports by using the marginal propensity to consume and the marginal
propensity to import?
Page 655
1. What is the relationship between aggregate planned expenditure and real GDP at
equilibrium expenditure?
2. How does equilibrium expenditure come about? What adjusts to achieve
equilibrium?
3. If real GDP and aggregate expenditure are less than equilibrium expenditure, what
happens to firms’ inventories? How do firms change their production? And what
happens to real GDP?
4. If real GDP and aggregate expenditure are greater than equilibrium expenditure,
what happens to firms’ inventories? How do firms change their production? And
what happens to real GDP?
Page 660
1. What is the multiplier? What does it determine? Why does it matter?
2. How do the marginal propensity to consume, the marginal propensity to import,
and the income tax rate influence the multiplier?
3. How do fluctuations in autonomous expenditure influence real GDP?
Page 665
1. How does a change in the price level influence the AE curve and the AD curve?
2. If autonomous expenditure increases with no change in the price level, what
happens to the AE curve and the AD curve? Which curve shifts by an amount that
is determined by the multiplier and why?
3. How does an increase in autonomous expenditure change real GDP in the short
run? Does real GDP change by the same amount as the change in aggregate
demand? Why or why not?
4. How does real GDP change in the long run when autonomous expenditure
increases? Does real GDP change by the same amount as the change in
aggregate demand? Why or why not?
Page 671
In an economy, autonomous consumption expenditure is $50 billion, investment is
$200 billion, and government expenditure is $250 billion. The marginal propensity to
consume is 0.7 and net taxes are $250 billion. Exports are $500 billion and imports are
$450 billion. Assume that net taxes and imports are autonomous and the price level is
fixed.
a. What is the consumption function?
b. What is the equation of the AE curve?
c. Calculate equilibrium expenditure.
d. Calculate the multiplier
e. If investment decreases to $150 billion, what is the change in equilibrium
expenditure?
f. Describe the process in part (e) that moves the economy to its new equilibrium
expenditure.
1. In an economy, when disposable income increases from $400 billion to $500
billion, consumption expenditure changes from $420 billion to $500 billion.
Calculate the marginal propensity to consume, the change in saving, and the
marginal propensity to save.
Use Figure 27.1 to work Problems 2 and 3.
Figure 27.1 illustrates the components of
aggregate planned expenditure on Turtle
Island. Turtle Island has no imports or
exports, no incomes taxes, and the price
level is fixed.2. Calculate autonomous expenditure
and the marginal propensity to
consume.
3. a. What is aggregate planned expenditure when real GDP is $6 billion?
b. If real GDP is $4 billion, what is happening to inventories?
c. If real GDP is $6 billion, what is happening to inventories?
4. Explain why induced consumption expenditure differs from autonomous
consumption expenditure. Why isn’t all consumption expenditure induced
expenditure?
5. Explain how an increase in business investment at a constant price level changes
equilibrium expenditure.
Use the following data to work Problems 6 and 7.

An economy has a fixed price level, no imports, and no income taxes. MPC is 0.80, and
real GDP is $150 billion. Businesses increase investment by $5 billion.6. Calculate the multiplier and the change in real GDP.
7. Calculate the new real GDP and explain why real GDP increases by more than $5
billion.
8. An economy has a fixed price level, no imports, and no income taxes. An increase
in autonomous expenditure of $200 billion increases equilibrium expenditure by
$800 billion. Calculate the multiplier and explain what happens to the multiplier if
an income tax is introduced.
9. Explain the link between equilibrium expenditure and the quantity of real GDP
demanded.
Use the following data to work Problems 10 to 14.
Suppose that the economy is at full employment, the price level is 100, and the
multiplier is 2. Investment increases by $100 billion.
10. What is the change in equilibrium expenditure if the price level remains at 100?
11. a. What is the immediate change in the quantity of real GDP demanded?
b. In the short run, does real GDP increase by more than, less than, or the same
amount as the immediate change in the quantity of real GDP demanded?
12. In the short run, does the price level remain at 100? Explain why or why not.
13. a. Compare the change in real GDP in the long run with the increase in investment.
b. Explain how the price level changes in the long run.
14. Are the values of the multipliers in the short run and the long run larger or smaller
than 2?
15. Use the data in the Worked Problem on p. 673. Calculate the change in
equilibrium expenditure when investment decreases by $50 billion.
Use the following data to work Problems 16 and 17.
You are given the information in the table about the
economy of Australia.
16. Calculate the marginal propensity to save.
17. Calculate consumption at each level of disposable income. Calculate the marginal
propensity to consume.
Use the following news clip to work Problems
18 to 20.
Canadian’s Wealth Rises
Gains in stock markets and increased house prices boosted Canadians’ wealth in the
first quarter of 2014. On a per capita basis, household wealth rose to $222,600.
Statistics Canada also reported that consumption expenditure increased by $4 billion
in the first quarter of 2014.
Sources: Toronto Star, September 11, 2014 and Statistics Canada
18. Explain why higher share prices and house prices are equivalent to saving
19. Explain how a rise in household wealth would be expected to influence
consumption expenditure and saving and how the consumption function and the
saving function would change.
20. Draw a graph to illustrate how a rise in household wealth would change the
consumption function and saving function.
Use the spreadsheet above, which lists real GDP (Y ) and the components of aggregate
planned expenditure in billions of dollars, to work Problems 21 and 22.
21. Calculate autonomous expenditure. Calculate the marginal propensity to
consume.
22. a. What is aggregate planned expenditure when real GDP is $200 billion?
b. If real GDP is $200 billion, explain the process that moves the economy toward
equilibrium expenditure.
c. If real GDP is $500 billion, explain the process that moves the economy toward
equilibrium expenditure.
23. Wholesale Inventories Decline, Sales Rise
The U.S. Commerce Department reported that wholesale inventories fell 1.3
percent in August for a record 12th consecutive month, evidence that companies
are trimming orders to factories, which helped depress economic output during
the recession. Economists hope that the rising sales will encourage businesses
to begin restocking their inventories, which would boost factory production and
help bolster broad economic growth in coming months.
Source: The New York Times, October 8, 2009
Explain why a fall in inventories is associated with recession and a restocking of
inventories might bolster economic growth.
24. On January 27, 2009, the government announced a stimulus package, which
included $12 billion earmarked for infrastructure—the construction of roads,
bridges, public transit, broadband Internet access, schools, and social housing in
every region of the country.
If the slope of the AE curve is 0.7, calculate the immediate change in aggregate
planned expenditure and the change in real GDP in the short run if the price level
remains unchanged.
25. Obama’s Economic Recovery Plan
President Obama’s proposal to jolt a listless recovery with $180 billion worth of
tax breaks and transportation projects left economists largely unimpressed
Tuesday.
Source: USA Today, September 10, 2010
If taxes fall by $90 billion and the spending on transport projects increases by $90
billion, which component of Obama’s recovery plan would have the larger effect
on equilibrium expenditure, other things remaining the same?
Use the following news item to work Problems 26 to 28.
Statistics Canada reported that in the second quarter of 2014 Canadian exports
increased by $24 billion.
26. Explain and draw a graph to illustrate
the effect of an increase in exports
on equilibrium expenditure in the
short run.
27. Explain and draw a graph to
illustrate the effect of an increase in
exports on equilibrium real GDP in
the short run.
28. Explain and draw a graph to
illustrate the effect of an increase in
exports on equilibrium real GDP in
the long run.
29. Compare the multiplier in the short run and the long run and explain why they are
not identical.
Use the following news clip to work Problems 30 to 32.
Consumer Sentiment Rose to Three-Month High
Consumer sentiment was up in August helped by merchant discounts, especially from
auto dealerships who received incentives from automakers Honda, General Motors,
and Toyota to lower prices.
But consumers are worried about the future. They are worried about tax changes and
government budget cuts that are on the horizon. Capital spending fell somewhat.
Source: Bloomberg, September 1, 2012
30. Which of the expenditures listed in the news clip are part of induced expenditure
and which is part of autonomous expenditure?
31. Which of the events reported in the news clip would change aggregate demand and which would change the quantity of real GDP demanded? Provide a graphical illustration of the distinction.
32. Explain and draw a graph to illustrate how increasing consumer confidence
influences aggregate expenditure and aggregate demand.
33. Japan Slides Into Recession
In Japan, consumer prices slid at a faster pace in July and industrial production
unexpectedly slumped.
Source: Bloomberg, September 1, 2012
Contrast what the news clip says is happening in Japan with what is happening in
Canada in Problem 34 and provide a graphical analysis of the differences.
34. After you have studied Economics in the News on pp. 666–667, answer the
following questions.
a. If in the second quarter of 2014 the change in inventories was a planned change,
what role did it play in shifting the AE curve and the changing equilibrium
expenditure? Use a two-part figure (similar to that on p. 667) to answer this
question.
b. The Statistics Canada report says that an increase in consumption expenditure
was the main reason why real GDP increased. How do we know that most of the
increase in consumption expenditure was autonomous?
c. Using the assumptions made in Figure 2 on p. 667, what is the slope of the AE
curve and what is the value of the autonomous expenditure multiplier?
multiplier?
35. In an economy with a fixed price level, autonomous spending is $20 billion and
the slope of the AE curve is 0.6.
a. What is the equation of the AE curve?
b. Calculate equilibrium expenditure.
c. Calculate the multiplier.
d. Calculate the shift of the aggregate demand curve if investment increases by $1
billion.
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