Macroeconomics Study Set 63

Business

Quiz 11 :

The Aggregate Expenditures Model

Quiz 11 :

The Aggregate Expenditures Model

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Assuming the economy is operating below its potential output, what is the impact of an increase in net exports on real GDP? Why is it difficult, if not impossible, for a country to boost its net exports by increasing its tariffs during a global recession?
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If the economy is operating below its capacity, an increase in net exports will increase real GDP. Like consumption and investment, net exports create domestic production.
It is difficult for a country to boost real GDP by increasing its tariffs during a global recession because this will induce retaliation from the trading partner, who tends to reduce imports from the domestic country. With retaliation in the picture, the reduced exports may be larger than the reduced imports, making net exports fall.

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What is an investment schedule and how does it differ from an investment demand curve?
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An investment schedule shows the amounts business firms collectively intend to invest - their planned investment - at each possible level of GDP. It does not change with GDP. An investment demand curve and the interest rate together determine the investment schedule. Investment demand is a function of interest rate.
Investment schedule differ from investment demand curve because investment schedule is constant and is a horizontal line with GDP on the horizontal axis (graph 1); whereas investment demand curve is a downward sloping line with interest rate on the vertical axis (graph 2).
img img img

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Suppose that a certain country has an MPC of.9 and a real GDP of $400 billion. If its investment spending decreases by $4 billion, what will be its new level of real GDP?
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Multiplier determines how much GDP will change in accordance with the change in spending, which depends on MPC. First we calculate the multiplier.
img Then we calculate the change in real GDP.
img Lastly we calculate the final level of real GDP, denoted by GDP'.
img img

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Why is saving called a leakage ? Why is planned investment called an injection ? Why must saving equal planned investment at equilibrium GDP in the private closed economy? Are unplanned changes in inventories rising, falling, or constant at equilibrium GDP? Explain.
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Why does equilibrium real GDP occur where C + Ig = GDP in a private closed economy? What happens to real GDP when C + Ig exceeds GDP? When C + Ig is less than GDP? What two expenditure components of real GDP are purposely excluded in a private closed economy?
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What is a recessionary expenditure gap? An inflationary expenditure gap? Which is associated with a positive GDP gap? A negative GDP gap?
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Advanced Analysis Assume that the consumption schedule for a private open economy is such that consumption C = 50 + 0.8 Y. Assume further that planned investment Ig and net exports Xn are independent of the level of real GDP and constant at Ig = 30 and Xn = 10. Recall also that, in equilibrium, the real output produced ( Y ) is equal to aggregate expenditures: Y = C + Ig + Xn.
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Refer to columnS1 and 6 in the table for problem 5. Incorporate government into the table by assuming that it plans to tax and spend $20 billion at each possible level of GDP. Also assume that the tax is a personal tax and that government spending does not induce a shift in the private aggregate expenditures schedule. What is the change in equilibrium GDP caused by the addition of government? img
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Refer to the accompanying table in answering the questions that follow: img a. If full employment in this economy iS130 million, will there be an inflationary expenditure gap or a recessionary expenditure gap? What will be the consequence of this gap? By how much would aggregate expenditures in column 3 have to change at each level of GDP to eliminate the inflationary expenditure gap or the recessionary expenditure gap? What is the multiplier in this example? b. Will there be an inflationary expenditure gap or a recessionary expenditure gap if the full-employment level of output is $500 billion? By how much would aggregate expenditures in column 3 have to change at each level of GDP to eliminate the gap? What is the multiplier in this example? c. Assuming that investment, net exports, and government expenditures do not change with changes in real GDP, what are the sizes of the MPC, the MPS, and the multiplier?
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Assume that, without taxes, the consumption schedule of an economy is as follows: img a. Graph this consumption schedule and determine the MPC. b. Assume now that a lump-sum tax is imposed such that the government collects $10 billion in taxes at all levels of GDP. Graph the resulting consumption schedule and compare the MPC and the multiplier with those of the pretax consumption schedule.
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The data in columnS1 and 2 in the accompanying table are for a private closed economy: img a. Use columnS1 and 2 to determine the equilibrium GDP for this hypothetical economy. b. Now open up this economy to international trade by including the export and import figures of columnS3 and 4. Fill in columns 5 and 6 and determine the equilibrium GDP for the open economy. What is the change in equilibrium GDP caused by the addition of net exports? c. Given the original $20 billion level of exports, what would be net exports and the equilibrium GDP if imports were $10 billion greater at each level of GDP? d. What is the multiplier in this example?
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Depict graphically the aggregate expenditures model for a private closed economy. Now show a decrease in the aggregate expenditures schedule and explain why the decline in real GDP in your diagram is greater than the decline in the aggregate expenditures schedule. What is the term used for the ratio of a decline in real GDP to the initial drop in aggregate expenditures?
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LAST WORD What is Say's law? How does it relate to the view held by classical economists that the economy generally will operate at a position on its production possibilities curve (Chapter 1)? Use production possibilities analysis to demonstrate Keynes' view on this matter.
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Explain graphically the determination of equilibrium GDP for a private economy through the aggregate expenditures model. Now add government purchases (any amount you choose) to your graph, showing its impact on equilibrium GDP. Finally, add taxation (any amount of lump-sum tax that you choose) to your graph and show its effect on equilibrium GDP
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Using the consumption and saving data in probleM1 and assuming investment is $16 billion, what are saving and planned investment at the $380 billion level of domestic output? What are saving and actual investment at that level? What are saving and planned investment at the $300 billion level of domestic output? What are the levels of saving and actual investment? In which direction and by what amount will unplanned investment change as the economy moves from the $380 billion level of GDP to the equilibrium level of real GDP? From the $300 billion level of real GDP to the equilibrium level of GDP?
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Other things equal, what effect will each of the following changes independently have on the equilibrium level of real GDP in the private closed economy?a. A decline in the real interest rate. b. An overall decrease in the expected rate of return on investment. c. A sizeable, sustained increase in stock prices.
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By how much will GDP change if firms increase their investment by $8 billion and the MPC is.80? If the MPC is.67?
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Answer the following questions, which relate to the aggregate expenditures model:
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Assuming the level of investment is $16 billion and independent of the level of total output, complete the accompanying table and determine the equilibrium levels of output and employment in this private closed economy. What are the sizes of the MPC and MPS?
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