Test Review Sheet for Unit #4

Test Review Sheet for Unit #4


Test Review Sheet for Unit #4

1) Know what disposable income (DI) is & how it relates to the consumption & savings function.

  1. Consumption Function = Autonomous consumption + MPC (DI)

2) Understand the marginal propensity to consume (MPC) and the marginal propensity to save (MPS) .

  1. What do they measure?
  2. Why do they always add up to 1?
  3. How do they affect the size of the multiplier? As MPC rises the multiplier ______

3) Understand what shifts the consumption function and savings function.

Consumption = Autonomous Consumption + MPC (DI)

Slope of consumption function = MPC, Savings function slope = MPS

4) Understand how to calculate the 3 multipliers which determine the “power” of fiscal policy

1) Government spending/investment multiplier

2) Tax multiplier

3) Balanced Budget Multiplier

Factors which make fiscal policy either more or less effective:

Multiplier, net export effect, state/local taxes, automatic stabilizers, crowding out, policy lag

5) List the factors which make Fiscal Policy more effective:

6) List the factors which make Fiscal Policy less effective.

7) Write the formula for: (hint: use Y = C + I + G + NX as your starting point… then convert to closed economy)

  1. Private Savings______
  1. Public Savings______
  1. National Savings______

8) Understand the short run and long run tradeoff between Unemployment and Inflation

  1. i.e. what shifts the short run Phillips Curve (SRPC)? What direction?
  2. What determines where you draw the long run Phillips curve on the x-axis? Does it shift?

9) Understand how a shift of AD will move you up or down both the SRAS & the SRPC

10) Understand that this unit is still about the effectiveness of basic Fiscal Policy.

  1. Many factors shift AD to the right in the SHORT RUN.
  1. How far will AD shift right depends on the size of the multiplier and the various offsetting factors listed on the first page
  1. For example, if crowding out occurs, how will this impact your fiscal policy?

Big Picture: Regardless of the SHORT RUN IMPACT => In the long run the factors which affect our full potential output are what really matter. That is our level of land, labor, human capital, physical capital, technology etc…. If we increase this “potential” (shift PPF) then real GDP will permanently increase.

In the short run, many factors influence real GDP due to sticky wages & prices. But In the long run wages and prices are perfectly flexible and the economy always returns to full potential output!

11) In the graph above shift AD to the right for the impact of a $2 billion increase in Gov’t Spending

  1. Assume MPC = .90 Assume full potential output = $100 billion & Y1 = $90 billion
  2. What is the new $ level of Real GDP? Is the new equilibrium above or below full potential?
  3. Find a Long run equilibrium assuming the Gov’t take no additional policy