Chapter 19
The Keynesian Model in Action
1. Using C to represent consumption, I to represent investment, G to represent government spending, S to represent saving, X to represent exports, and M to represent imports, aggregate expenditures can be represented by
a. C + I + G + (X + M).
b. (C - S) + G + (X - M).
c. C + I + G + (X - M).
d. C + I + G + (X - M) - S.
ANS
a. Incorrect. See the correct formula in answer c.
b. Incorrect. See the correct formula in answer c.
c. Correct. AE = C + I + G + (X - M).
d. Incorrect. See the correct formula in answer c.
2. In the aggregate expenditures model, if aggregate expenditures (AE) are less than GDP, then
a. inventory is depleted.
b. inventory is unchanged.
c. employment decreases.
d. employment increases.
ANS
a. Incorrect. In this case, inventory is accumulated.
b. Incorrect. In this case, inventory is accumulated.
c. Correct. In the aggregate expenditures model, if aggregate expenditures (AE) are less than GDP, then employment decreases.
d. Incorrect. In the aggregate expenditures model, if aggregate expenditures (AE) are less than GDP, then employment decreases.
3. Which one of the following are the components of aggregate expenditures?
a. household consumption, business investment, government spending for goods and services, and net exports
b. household consumption, business investment, government transfer payments, and net exports
c. household consumption, business investment, government spending for goods and services, and exports
d. household consumption, business investment, government spending for goods and services, and saving
ANS
a. Correct. AE = C + I + G + (X - M).
b. Incorrect. Transfer payments are not included in GDP.
c. Incorrect. AE includes net exports (X - M).
d. Incorrect. AE does not include savings.
4. In the Keynesian model, investment, government spending, and net exports are treated as autonomous expenditures, which means they are independent of
a. expectations.
b. the price level.
c. political processes.
d. real GDP.
ANS
a. Incorrect. Changes in expectations can shift investment (I).
b. Incorrect. The price level is held constant in the model.
c. Incorrect. Political processes affect government spending ( C ).
d. Correct. Autonomous expenditures by definition are independent of real GDP.
Exhibit 10 Keynesian aggregate expenditures model
5. As shown in Exhibit 10, equilibrium GDP is
a. $2 trillion.
b. $6 trillion.
c. $10 trillion.
d. $12 trillion.
ANS
a. Incorrect. At $2 trillion, the AE and 45° lines are unequal.
b. Incorrect. At $6 trillion, the AE and 45° lines are unequal.
c. Correct. At $10 trillion, the AE and 45° lines are unequal.
d. Incorrect. At $10 trillion real GDP, the AE and 45° lines are equal.
6. As shown in Exhibit 10, if GDP is $6 trillion, the economy experiences unplanned inventory
a. depletion of $2 trillion.
b. depletion of $6 trillion.
c. accumulation of $2 trillion.
d. accumulation of $6 trillion.
ANS
a. Correct. At $6 trillion real GDP, the 45° line (aggregate supply, AS) is less than aggregate expenditures (AE) by $2 trillion, and inventories are depleted by this amount.
b. Incorrect. At $6 trillion real GDP, the 45° line (aggregate supply, AS) is less than aggregate expenditures (AE) by $2 trillion, and inventories are depleted by this amount.
c. Incorrect. At $6 trillion real GDP, the 45° line (aggregate supply, AS) is less than aggregate expenditures (AE) by $2 trillion, and inventories are depleted by this amount.
d. Incorrect. At $6 trillion real GDP, the 45° line (aggregate supply, AS) is less than aggregate expenditures (AE) by $2 trillion, and inventories are depleted by this amount.
7. As shown in Exhibit 10, if GDP is $14 trillion, the economy experiences unplanned inventory
a. accumulation of $12 trillion.
b. depletion of $14 trillion.
c. accumulation of $2 trillion.
d. depletion of $4 trillion.
ANS
a. Incorrect. At $14 trillion real GDP, the 45° line (aggregate supply, AS) exceeds the aggregate expenditure (AE) by $2 trillion.
b. Incorrect. At $14 trillion real GDP, the 45° line (aggregate supply, AS) exceeds the aggregate expenditure (AE) by $2 trillion.
c. Correct. At $14 trillion real GDP, the 45° line (aggregate supply, AS) exceeds the aggregate expenditure (AE) by $2 trillion.
d. Incorrect. At $14 trillion real GDP, the 45° line (aggregate supply, AS) exceeds the aggregate expenditure (AE) by $2 trillion.
8. The ratio of the change in GDP to an initial change in aggregate expenditures (AE) is the
a. spending multiplier.
b. permanent income rate.
c. marginal expenditure rate.
d. marginal propensity to consume.
ANS
a. Correct. The ratio of the change in GDP to an initial change in aggregate expenditures (AE) is the spending multiplier.
b. Incorrect. This is a meaningless term.
c. Incorrect. This is a meaningless term.
d. Incorrect. MPC is the change in consumption resulting from a given change in real disposable income.
9. The formula to compute the spending multiplier is
a. 1/(MPC + MPS).
b. 1/(1 - MPC).
c. 1/(1 - MPS).
d. 1/(C + I).
ANS
a. Incorrect. The formula to compute the spending multiplier is 1/(1 - MPC).
b. Correct. The formula to compute the spending multiplier is 1/(1 - MPC).
c. Incorrect. The formula to compute the spending multiplier is 1/(1 - MPC).
d. Incorrect. The formula to compute the spending multiplier is 1/(1 - MPC).
10. If the marginal propensity to consume (MPC) is 0.80, the value of the spending multiplier is
a. 2.
b. 5.
c. 8.
d. 10.
ANS
a. Incorrect. See the correct calculation in answer b.
b. Correct. Spending multiplier = 1/(1-MPC) - 1/.20 = 5.
c. Incorrect. See the correct calculation in answer b.
d. Incorrect. See the correct calculation in answer b.
11. When households' marginal propensity to consume (MPC) increases, the size of the spending multiplier
a. also increases.
b. decreases.
c. remains unchanged.
d. reacts unpredictably.
ANS
a. Correct. When households' marginal propensity to consume (MPC) increases, the size of the spending multiplier also increases.
b. Incorrect. When households' marginal propensity to consume (MPC) increases, the size of the spending multiplier also increases.
c. Incorrect. When households' marginal propensity to consume (MPC) increases, the size of the spending multiplier also increases.
d. Incorrect. When households' marginal propensity to consume (MPC) increases, the size of the spending multiplier also increases.
12. Mathematically, the value of the spending multiplier is given by the formula
a. MPC - 1.
b. (MPC -1)/MPC.
c. 1/MPC.
d. 1/MPS.
ANS
a. Incorrect. Mathematically, the value of the spending multiplier is given by the formula 1/MPS.
b. Incorrect. Mathematically, the value of the spending multiplier is given by the formula 1/MPS.
c. Incorrect. Mathematically, the value of the spending multiplier is given by the formula 1/MPS.
d. Correct. Mathematically, the value of the spending multiplier is given by the formula 1/MPS.
13. Assume the economy is in recession, the MPC is 0.80, and an increase of $200 billion in spending is needed to reach full employment. The target can be reached if government spending is increased by
a. $20 billion.
b. $200 billion.
c. $80 billion.
d. $40 billion.
ANS
a. Incorrect. See the correct calculation in answer d.
b. Incorrect. See the correct calculation in answer d.
c. Incorrect. See the correct calculation in answer d.
d. Correct. SM = 1/(1 - .80) = 1/.20 = 5; DG x 5 = $200 billion; DG = $40 billion.
14. Using the aggregate expenditures model, assume the aggregate expenditures (AE) line is above the 45-degree line at full-employment GDP. This vertical distance is called a (an)
a. inflationary gap.
b. recessionary gap.
c. negative GDP gap.
d. marginal propensity to consume gap.
ANS
a. Correct. In this case, macro equilibrium would be above full-employment real GDP, and there is an inflationary gap.
b. Incorrect. In this case, macro equilibrium would be above full-employment real GDP, and there is an inflationary gap.
c. Incorrect. This is positive GDP gap.
d. Incorrect. This is a meaningless term.
15. Assume that full-employment real GDP is Y = $1,200 billion, the current equilibrium real GDP is Y = $1,600 billion, and the MPC = 0.8.To bring the economy to a full-employment real GDP,
a. a recessionary gap must be bridged by increasing aggregate expenditures by $80 billion.
b. an inflationary gap must be bridged by cutting aggregate expenditures by $80 billion.
c. nothing is needed to bring the economy into full employment equilibrium.
d. a recessionary gap must be bridged by increasing aggregate expenditures by $400 billion.
e. an inflationary gap must be bridged by cutting aggregate expenditures by $400 billion.
ANS
a. Incorrect. See answer b. for the correct calculation.
b. Correct. Spending multiplier = 1/(1 - MPC) = 1/(1 - .80) = 5; DG x SM = DY; DG x 5 = -$400; DG = - 80.
c. Incorrect. See answer b. for the correct calculation.
d. Incorrect. See answer b. for the correct calculation.
16. If the MPC is 0.70, then the spending multiplier is equal to
a. 0.70.
b. 0.30.
c. 0.14.
d. 3.33.
e. 5.
ANS
a. Incorrect. MPC = 1/(1 - MPC) = 1/(1 - 0.70) = 1 = 10 = 3.33.
0.30 3
b. Incorrect. MPC = 1/(1 - MPC) = 1/(1 - 0.70) = 1 = 10 = 3.33.
0.30 3
c. Incorrect. MPC = 1/(1 - MPC) = 1/(1 - 0.70) = 1 = 10 = 3.33.
0.30 3
d. Correct. MPC = 1/(1 - MPC) = 1/(1 - 0.70) = 1 = 10 = 3.33.
0.30 3
e. Incorrect. MPC = 1/(1 - MPC) = 1/(1 - 0.70) = 1 = 10 = 3.33.
0.30 3
17. The equilibrium level of real GDP is $1,000, the target full-employment level of real GDP is $1,500, and the marginal propensity to consume is 0.75. The target can be reached if government spending is
a. increased by $100 billion.
b. increased by $125 billion.
c. increased by $500 billion.
d. held constant.
ANS
a. Incorrect. Spending multiplier = 1/(1-MPC) = 1/(1-.75) = 4;
DG x SM = DY; DG x 4 = $500 billion; D = $125 billion.
b. Correct. Spending multiplier = 1/(1-MPC) = 1/(1-.75) = 4;
DG x SM = DY; DG x 4 = $500 billion; D = $125 billion.
c. Incorrect. Spending multiplier = 1/(1-MPC) = 1/(1-.75) = 4;
DG x SM = DY; DG x 4 = $500 billion; D = $125 billion.
d. Incorrect. Spending multiplier = 1/(1-MPC) = 1/(1-.75) = 4;
DG x SM = DY; DG x 4 = $500 billion; D = $125 billion.
Exhibit 11 Keynesian aggregate expenditures model
18. In Exhibit 11 an increase in aggregate expenditures causes
a. a movement down the aggregate expenditures curve from equilibrium real GDP of $600 to equilibrium real GDP $1,000.
b. a movement up the aggregate expenditures curve from equilibrium real GDP of
$1,200 to equilibrium real GDP $1,000.
c. a shift of the aggregate expenditures curve to the right, causing equilibrium real
GDP to increase from $600 to $1,000.
d. a shift of the aggregate expenditures curve to the left, causing equilibrium real GDP
to decrease from $1,200 to $1,000.
e. no change in equilibrium real GDP.
ANS
a. Incorrect. Initially the economy is in equilibrium at $600. The increase in $200 shifts equilibrium to $1,000-an increase of $400.
b. Incorrect. Initially the economy is in equilibrium at $600. The increase in $200 shifts equilibrium to $1,000-an increase of $400.
c. Correct. Initially the economy is in equilibrium at $600. The increase in $200 shifts equilibrium to $1,000-an increase of $400.
d. Incorrect. Initially the economy is in equilibrium at $600. The increase in $200 shifts equilibrium to $1,000-an increase of $400.
e. Incorrect. Initially the economy is in equilibrium at $600. The increase in $200 shifts equilibrium to $1,000-an increase of $400.
19. In Exhibit 11, the value of the spending multiplier is
a. 3.
b. 4.
c. 5.
d. 2.
e. 6.
ANS
a. Incorrect. The MPC is the slope of the AE line. The spending multiplier equals 1/(1-MPC); 1/(1-0.50) = 2.
b. Incorrect. The MPC is the slope of the AE line. The spending multiplier equals 1/(1-MPC); 1/(1-0.50) =2.
c. Incorrect. The MPC is the slope of the AE line. The spending multiplier equals 1/(1-MPC); 1/(1-0.50) = 2.
d. Correct. The MPC is the slope of the AE line. The spending multiplier equals 1/(1-MPC); 1/(1-0.50) = 2.
20. In Exhibit 11, assume the AE2 line is aggregate expenditures and $1,000 is full-employment real GDP. If the economy operates at a real disposable income of $600, there will be
a. inventory accumulation of $100.
b. inventory accumulation of $200.
c. zero inventory.
d. inventory deletion of $200.
ANS
a. Incorrect. At $600, read the vertical distance between the AE2 line and the 45 degree line, which is $200 excess spending over aggregate supply.
b. Incorrect. At $600, read the vertical distance between the AE2 line and the 45 degree line, which is $200 excess spending over aggregate supply.
c. Incorrect. At $600, read the vertical distance between the AE2 line and the 45 degree line, which is $200 excess spending over aggregate supply.
d. Correct. At $600, read the vertical distance between the AE2 line and the 45 degree line, which is $200 excess spending over aggregate supply.
9