# Economics

## Quiz 24 :The Monetary System

Question Type
Simple Spending Multiplier Suppose that the MPC is 0.8, while investment, government purchases, and net exports sum to $500 billion. Suppose also that the government budget is in balance. a. What is the sum of saving and net taxes when desired spending equals real GDP? Explain. b. What is the value of the multiplier? c. Explain why the multiplier is related to the slope of the consumption function. Free Essay Answer: Answer: The MPC, or marginal propensity to consume, is a value between 0 and 1 that describes an individual's consumption habits. For example, if Joe has an MPC of 0.7, that means he has a propensity to spend 70% of his income. If his income increases by$100, his consumption spending will increase by $70. This is the simple characteristic of the MPc.(a)GDP refers to the gross domestic product of a nation. It's a measure of all the expenditure in that nation within a given time. Typically referred to as Y , it is calculated via the formula below, where C is consumption, I is investment, G is government spending, X is exports, and M is imports. In this example, investment plus government spending plus net exports equal$500 billion. Therefore, savings and net taxes must also sum to $500 billion. This is a fundamental property of the GDP calculation via the formula below, where S is saving and T is taxes. (b)The spending multiplier is a value that describes the factor by which a change in spending changes GDP. It is calculated below where M is the multiplier. Therefore, the spending multiplier is 5. (c)The consumption function describes the change in an individual's consumption as his or her income changes. This value is also the slope of the consumption function. Therefore, it is by definition the MPC, or marginal propensity to consume. Along this, it is clear how the consumption function and spending multiplier are related. The multiplier calculation is included below. With this in mind, it becomes clear that the multiplier and slope of the consumption function depend upon one another. Tags Choose question tag REAL GDP DEMANDED In your own words, explain the logic of the income-expenditure model. What determines the amount of real GDP demanded? Free Essay Answer: Answer: Aggregate Income-Expenditure Model Assuming there is no depreciation of capital stock or no fall in net inventories and no savings of firms, aggregate income-expenditure model states that each dollar of expenditure on final goods and services results in a dollar of income.In simple words, income-expenditure model states that when there is no depreciation of capital stock and no business saving, then an economy's aggregate expenditure results in aggregate income, which is equal to the real gross domestic product (Real GDP). Determination of Real GDP demanded Real GDP is determined at the intersection point between the aggregate expenditure line and the 45-degree line. The 45-degree line reflects the locus of points where aggregate income is equal to the real GDP. In simple words, income-expenditure model states that at the given price level, real GDP demanded is determined where the aggregate expenditure and real GDP are equal. Real GDP can be stated as the aggregate output or aggregate income. Real GDP is measured on horizontal axis and aggregate expenditure is measured on vertical axis. Below the intersection point, desired spending is more than the real GDP and above the intersection point, real GDP is more than the desired spending. Tags Choose question tag Suppose that C = 100 + 0.75( Y - 100), I = 50, G = 30, and X - M = -100, all in billions of dollars. What is the simple spending multiplier? What is real GDP demanded? What would happen to real GDP demanded if government purchases increased to$40 billion?
Free
Essay

In this example, a lot of information is provided in billions of dollars. The consumption function is as follows, where C is consumption and Y is income. Investment, or I is equal to 50. G , or government spending, is 30. Net exports, X - M , is equal to -100.
To calculate the spending multiplier, the MPC must be located in the given information. Consumption functions typically take the form:
In this equation, b is the marginal propensity to consume and NT is net taxes. Thus, in the provided equation, the MPC is 0.75. The calculation of the spending multiplier is as follows:
To calculate real GDP, or Y , the standard equation C + I + G + X - M is used. It is as follows, in billions of dollars.
Government spending influences GDP much the same way that consumption spending does. Therefore, it is subject to the same multiplier that was calculated above. Initially G is $30 billion; now it is$40 billion.
Thus, an increase in government spending of $40 billion would result in an increase in Y of$40 billion.

Tags
Choose question tag
Case Study: The Ripple Effect of 9/11 How do events, such as the World Trade Center and Pentagon attacks described in the case study "The Ripple Effects of 9/11" affect the aggregate expenditure line and the aggregate demand curve? Explain fully. Reference Case study: Public Policy The Ripple Effect on the Economy of 9/11 When hijacked planes hit the World Trade Center and the Pentagon, America's sense of domestic security changed. The thousands of lives lost and the billions of dollars of property destroyed were chronicled at length in the media. Let's look at the impact of the tragedy on just one industry-air travel-to see how slumping demand there affected aggregate expenditure. Once aviation regulators became aware of the hijackings, they grounded all nonmilitary aircraft immediately. This cost the airlines hundreds of millions of dollars a day in lost business. During the days following the attack, video of the second plane crashing into the twin towers was shown again and again, freezing this image in people's minds and heightening public concerns about airline safety. These worries, coupled with the airport delays from added security (passengers were told to arrive up to three hours before flights), reduced the demand for air travel once planes were allowed to fly again. For short flights, it became quicker and easier to drive than to fly. Two weeks after the attacks, airlines were operating only 75 percent of their flights, and these flights were only 30 percent full instead of the usual 75 percent full. Airlines requested federal support, saying they would go bankrupt otherwise. Congress quickly approved a $15 billion aid package of loans and grants. Despite the promise of federal aid, airlines laid off 85,000 workers, or about 20 percent of their workforce. Flight reductions meant that as many as 900 aircraft would be parked indefinitely, so investment in new planes collapsed. Boeing, the major supplier of new planes and America's leading exporter, announced layoffs of 30,000 workers. This triggered layoffs among suppliers of aircraft parts, such as jet engines and electronic components. For example, Rockwell Collins, an electronics supplier, said 15 percent of its workforce would lose jobs. Other suppliers in the airline service chain also cut jobs. Sky Chef, a major airline caterer, laid off 4,800 of its 16,000 employees. Airports began rethinking their investment plans. Half the major U.S. airports said they were reevaluating capital improvement plans to see if these investments made sense in this new environment. Honolulu airport, for example, suspended plans to add extra gates and renovate its overseas terminals. Within three weeks after the attacks, job cuts announced in the industry exceeded 150,000. These were part of only the first round of reduced consumption and investment. In an expanding economy, job losses in one sector can be made up by job expansions in other sectors. But the U.S. economy was already in a recession at the time of the attack, having lost about a million jobs between March 2001 and September 2001. People who lost jobs or who feared for their jobs reduced their demand for housing, clothing, entertainment, restaurant meals, and other goods and services. For example, unemployed flight attendants would be less likely to buy new cars, reducing the income of autoworkers and suppliers. People who lost jobs in the auto industry would reduce their demand for goods and services. So the reductions in airline jobs had a ripple effect. Airlines are only one part of the travel industry. With fewer people traveling, fewer needed hotel rooms, rental cars, taxi rides, and restaurant meals. Each of those sectors generated a cascade of job losses. The terrorist attacks also shook consumer confidence, which in September 2001 suffered its largest monthly drop since October 1990, on the eve of the first Persian Gulf War. Within 10 days following the attacks, the number of people filing for unemployment benefits jumped to a nine-year high. Again, these early job losses could be viewed as just part of the first round of reduced aggregate expenditure. The second round would occur when people who lost jobs or who feared they would lose their jobs started spending less. The U.S. economy continued to shed jobs for nearly two years after the attacks, losing about 2 million more jobs. Researchers estimate that business interruptions resulting from the attacks cost the U.S. economy a little over$100 billion, or about 1 percent of GDP.
Essay
Tags
Choose question tag
AGGREGATE EXPENDITURE What are the components of aggregate expenditure? In the model developed in this chapter, which components vary with changes in the level of income? What determines the slope of the aggregate expenditure line?
Essay
Tags
Choose question tag
Shifts of Aggregate Demand Assume the simple spending multiplier equals 10. Determine the size and direction of any changes of the aggregate expenditure line, real GDP demanded, and the aggregate demand curve for each of the following changes in spending: a. Spending rises by $8 billion at each income level. b. Spending falls by$5 billion at each income level. c. Spending rises by $20 billion at each income level. Essay Answer: Tags Choose question tag SIMPLE SPENDING MULTIPLIER For each of the following values for the MPC, determine the size of the simple spending multiplier and the total change in real GDP demanded following a$10 billion decrease in spending: a. MPC = 0.9 b. MPC = 0.75 c. MPC = 0.6
Essay
Tags
Choose question tag
Net Exports and the Spending Multiplier Suppose that the marginal propensity to consume (MPC) is 0.8 and the marginal propensity to import (MPM) is 0.05. a. What is the value of the spending multiplier? b. By how much would the real GDP demanded change if investment increased by $100 billion? c. Using your answer to part (b), calculate the change in net exports caused by the change in aggregate output. Essay Answer: Tags Choose question tag WHEN OUTPUT AND SPENDING DIFFER What role do inventories play in determining real GDP demanded? In answering this question, suppose initially that firms are either producing more than people plan to spend, or producing less than people plan to spend. Essay Answer: Tags Choose question tag REAL GDP DEMANDED What equalities hold at the level of real GDP demanded? When determining real GDP demanded, what do we assume about the price level? What do we assume about inventories? Essay Answer: Tags Choose question tag SIMPLE SPENDING MULTIPLIER Suppose that the MPC is 0.8 and that$14 trillion of real GDP is currently being demanded. The government wants to increase real GDP demanded to \$15 trillion at the given price level. By how much would it have to increase government purchases to achieve this goal?
Essay
Tags
Choose question tag
INVESTMENT AND THE MULTIPLIER This chapter assumes that investment is independent of the income level in the economy. What would happen to the size of the multiplier if investment increases as real GDP increases? Explain.
Essay
Tags
Choose question tag
Simple Spending Multiplier "A rise in investment in an economy leads to a rise in spending." Use the spending multiplier to verify this statement.
Essay