Macroeconomics Study Set 63

Business

Quiz 10 :

Basic Macroeconomic Relationships

Quiz 10 :

Basic Macroeconomic Relationships

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What will the multiplier be when the MPS is 0,.4,.6, and 1? What will it be when the MPC iS1,.90,.67,.50, and 0? How much of a change in GDP will result if firms increase their level of investment by $8 billion and the MPC is.80? If the MPC instead is.67?
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MPS is the marginal propensity to save. The multiplier is the ratio of change in real GDP to initial change in spending.
img The fractions of an increase in income consumed and saved determine the cumulative spending effects of any initial change in spending and therefore determine the size of the multiplier. The MPC and the multiplier are directly related and the MPS and the multiplier are inversely related. The precise formulas are as shown in the next two equations:
img or
img a. When MPS is 0, 0.4, 0.6 and 1, the corresponding multipliers are calculated below:
img When MPS is 0.4
img When MPS is 0.6
img When MPS iS1
img When MPC iS1, 0.9, 0.67, 0.5, multiplier is calculated as follows:
img When MPC is 0.9, multiplier is calculated as follows:
img When MPC is 0.67, multiplier is calculated as follows:
img When MPC is 0.5, multiplier is calculated as follows:
img When MPC is 0, multiplier is calculated as follows:
img Multiplier determines how much GDP will change in accordance with the change in spending, which depends on MPC.
img img If the MPC is 0.67, the change in GDP is calculated as follows:
img img

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How is it possible for investment spending to increase even in a period in which the real interest rate rises?
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During expansion, the investment demand curve shifts to the right, as from ID to ID' in the figure below. This outward shift overwhelmed any investment-decreasing effects of the increase of real interest rates. The net result turned out to be more investment (I to I''), not less (I to I').
img The rightward shift of the investment demand reflected an increase in the expected returns from investment. Firms were facing an under-stock of existing capital relative to their current sales. Also firms were optimistic about the economy.

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Why is the actual multiplier in the U.S. economy less than the multiplier in this chapter's example?
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The actual multiplier in the is less than that in the example because income is spent on import and tax payment other than on savings. In the formula for multiplier, the multiplier and MPS are negatively related.
img In reality, part of income is spent on import and tax payment, thus the multiplier formula overstates the multiplier. The formula should be restated aS1 over consumption other than domestic expenditure on goods and services.
Besides, spending may be partly dissipated as inflation rather than realized fully as an increase in real GDP.

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Suppose that disposable income, consumption, and saving in some country are $200 billion, $150 billion, and $50 billion, respectively. Next, assume that disposable income increases by $20 billion, consumption rises by $18 billion and saving goes up by $2 billion. What is the economy's MPC? Its MPS? What was the APC before the increase in disposable income? After the increase?
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Suppose that an initial $10 billion increase in investment spending expands GDP by $10 billion in the first round of the multiplier process. If GDP and consumption both rise by $6 billion in the second round of the process, what is the MPC in this economy? What is the size of the multiplier? If, instead, GDP and consumption both rose by $8 billion in the second round, what would have been the size of the multiplier?
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Refer to the incomplete table below. img a. Fill in the missing numbers in the table. b. What is the break-even level of income in the table? What is the term that economists use for the saving situation shown at the $240 level of income? c. For each of the following items indicate whether the value in the table is either constant or variable as income changes: the MPS, the APC, the MPC, the APS.
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In what direction will each of the following occurrences shift the consumption and saving schedules, other things equal? a. A large decrease in real estate values, including private homes. b. A sharp, sustained increase in stock prices. c. A 5-year increase in the minimum age for collecting Social Security benefits. d. An economy-wide expectation that a recession is over and that a robust expansion will occur. e. A substantial increase in household borrowing to finance auto purchases.
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Advanced Analysis Linear equations for the consumption and saving schedules take the general form C = a + bY and S= -a + (1-b)Y where C , S , and Y are consumption, saving, and national income, respectively. The constant a represents the vertical intercept, and b represents the slope of the consumption schedule img b. What is the economic meaning of b ? Of (1 - b )? c. Suppose that the amount of saving that occurs at each level of national income falls by $20 but that the values of b and (1 - b ) remain unchanged. Restate the saving and consumption equations inserting the new numerical values, and cite a factor that might have caused the change.
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Assume there are no investment projects in the economy that yield an expected rate of return of 25 percent or more. But suppose there are $10 billion of investment projects yielding expected returns of between 20 and 25 percent; another $10 billion yielding between 15 and 20 percent; another $10 billion between 10 and 15 percent; and so forth. Cumulate these data and present them graphically, putting the expected rate of return (and the real interest rate) on the vertical axis and the amount of investment on the horizontal axis. What will be the equilibrium level of aggregate investment if the real interest rate is (a) 15 percent, (b) 10 percent, and (c) 5 percent?
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Refer to the table in FigurE27.5 in the book and suppose that the real interest rate is 6 percent. Next, assume that some factor changes such that that the expected rate of return declines by 2 percentage points at each prospective level of investment. Assuming no change in the real interest rate, by how much and in what direction will investment change? Which of the following might cause this change: (a) a decision to increase inventories; (b) an increase in excess production capacity?
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In what direction will each of the following occurrences shift the investment demand curve, other things equal? b. Business taxes decline. c. The costs of acquiring equipment fall. d. Widespread pessimism arises about future business conditions and sales revenues. e. A major new technological breakthrough creates prospects for a wide range of profitable new products.
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What are the variables (the items measured on the axes) in a graph of the (a) consumption schedule and (b) saving schedule? Are the variables inversely (negatively) related or are they directly (positively) related? What is the fundamental reason that the levels of consumption and saving in the United States are each higher today than they were a decade ago?
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Suppose a handbill publisher can buy a new duplicating machine for $500 and the duplicator has a 1-year life. The machine is expected to contribute $550 to the year's net revenue. What is the expected rate of return? If the real interest rate at which funds can be borrowed to purchase the machine is 8 percent, will the publisher choose to invest in the machine? Will it invest in the machine if the real interest rate is 9 percent? If it iS11 percent?
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Why will a reduction in the real interest rate increase investment spending, other things equal?
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Precisely how do the MPC and the APC differ? How does the MPC differ from the MPS? Why must the sum of MPC and the MPS equal 1?
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Advanced Analysis Suppose that the linear equation for consumption in a hypothetical economy is C = 40 +.8 Y. Also suppose that income ( Y ) is $400. Determine (a) the marginal propensity to consume, (b) the marginal propensity to save, (c) the level of consumption, (d) the average propensity to consume, (e) the level of saving, and (f) the average propensity to save.
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Why is investment spending unstable?
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Why does a downshift of the consumption schedule typically involve an equal upshift of the saving schedule? What is the exception to this relationship?
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Use your completed table for probleM1 to solve this problem. Suppose the wealth effect is such that $10 changes in wealth produce $1 changes in consumption at each level of income. If real estate prices tumble such that wealth declines by $80, what will be the new level of consumption at the $340 billion level of disposable income? The new level of saving?
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Is the relationship between changes in spending and changes in real GDP in the multiplier effect a direct (positive) relationship or is it an inverse (negative) relationship? How does the size of the multiplier relate to the size of the MPC? The MPS? What is the logic of the multiplier-MPC relationship?
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