Economics 102 Introductory Macroeconomics - Spring 2005, Professor J. Wissink
Economics 102 Introductory Macroeconomics - Spring 2005, Professor J. Wissink
Problem Set 4 - ANSWERS
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1)Using the following information.
a)Recall that AEd = C + Id + G + (X - M) and that in equilibrium Y* = AE. Hence the equilibrium level of national income, Y*is $600 billion, since at this level income will equal aggregate desired expenditure.
b)See graph.
c)Themarginal propensity to consume out of Y is mpc= C/Y = 0.8 (or 4/5)
d)The marginal propensity to invest out of Y is mpi = I/Y = 0
e)The marginal propensity to export out of Y mpx = X/Y = 0
f)The marginal propensity to import of Y mpm = M/Y = 0
g)Substituting the previous values we obtain that the investment multiplier is:
KI = 1/(1-mpc-mpi-mpx+mpm) = 1/(1-0.8) = 5
h)The investment multiplier tells us that for each exogenous increase in the level of planned investment by $1.00 we will generate a $5.00 increase in the equilibrium level of national income.
i)If planned investment exogenously increased by $2.5 billion then the equilibrium level of national income would rise by $12.5 billion (i.e. 2.5 billion times 5), ceteris paribus.
j)The budget is not balanced in this economy since T = 100 < 120 = G.
2. Multiple Choice:
1) If the “Keynesian” investment multiplier is 2.5 and if investment rises by $20 while government spending falls by $10 (other things remaining constant), by how much will the equilibrium level of income (Y*) rise?
a.0.
b.25.
c.40.
d.50.
e.By an indeterminate amount.
2) If income can only go to consumption and saving then the following must be true:
a.the mpc+mps = 1
b.the mps = 0.
c.the apc+aps = 1
d.both a. and c.
e.none of the above
3) In a closed economy with no government, which one of the following will occur when the economy is in equilibrium:
a.S=C
b.Y=S
c.C=Y
d.I=C
e.none of the above
4) A reduction in the marginal propensity to consume will:
a.cause the AEd line to become flatter and a given change in investment to have a smaller effect on output.
b.cause the AEd line to become flatter and a given change in investment to have a greater effect on output.
c.cause the AEd line to become steeper and a given change in investment to have a smaller effect on output.
d.cause the AEd line to become steeper and a given change in investment to have a great effect on output.
e.cause the AEd line to shift up.
5) Refer to the figure depicting the relationship between income received (Y) and consumption spending (C) for a given household. Assume there is no government spending and taxes. This household's saving will be zero when income is:
a.1,400.
b.1,200.
c.1,000.
d.800.
e. 600.
3.Consumption function: C = $300 + .6Yd
Investment: I = $500
Government spending: G = $200
Taxes: T = $200
Exports: EX = 0
Imports: IM = .2Y
a)AE d = C + Id + G + (X - M) = $300 + 0.6(Y – $200) + $500 + $200 + (0 – 0.2Y)
And in equilibrium AE d = Y*, so Y*(1 – 0.6 + 0.2) = $300 – 0.6($200) + $500 + $200 = 880
Hence, Y* = 1466.6 is the Isle de Cornell’s equilibrium level of output/income Y*.
b)
c)In this case, the multiplier for C and I and G and X would be 1/(1-MPC+MPM).
With the numbers above this equals 1/(1- 0.6+ 0.2) = 5/3 (approximately 1.66).
d)To calculate the balanced budget multiplier first figure out the tax multiplier. In this case the tax multiplier is -MPC/(1-MPC+MPM) = -.6/(1-.6+.2) = -1. Now, to get the BB multiplier, add the government multiplier to the tax multiplier and you get a balanced budget multiplier equal to 2/3 (approximately 0.66).
e)A lump-sum reduction of taxes by $50 will raise the equilibrium level of national income by$50, since the tax multiplier is -1 in this case. This helps the Isle de Cornell’s goal of growth, but it will raise the budgetary deficit.
f)Increasing government spending by $50 will raise the equilibrium level of national income by $83.3since the G multiplier is 5/3 in this case. This helps the Isle de Cornell’s goal of growth even more than the previous policy, but it will raise the budgetary deficit.
g)The policy of simultaneously increasing government spending by $50 and finance it with a lump-sum increase in taxes of $50will raise the equilibrium level of national income by $33.3,since the BB multiplier is 2/3 in this case. This helps the Isle de Cornell’s goal of growth but not as much as the previous two policies. However, it will not raise the budgetary deficit.
h)The final policy option of allowingFinland to sell wool socks to the Isle de Cornell economy will not help the goal of growth in the economy, since raising imports will decrease the equilibrium level of income.