Homework #4

1. True/False

a. If planned investment increases by $30 million and, as a result, national output increases by $60 million, the value of the multiplier is 2 and the value of the MPS is .25.

b. If the MPC is equal to .67, the multiplier is equal to approximately 3.

c. Assume a MPC of .75. If private planned investment decreases by $10 million and government spending increases by $13 million, the national income will increase by $12 million.

d. The multiplier is equal to the reciprocal of the MPS.

e. Income earned by productive resources does not include transfer payments.

f. According to the classical economists unemployment was a temporary deviation from equilibrium, and discretionary government spending would return the economy to full employment.

g. According to the classical approach if planned saving increases then the interest rate will increase.

h. Keynesian analysis is able to explain the determination of national income, output and employment.

i. If household income increases and almost all of that increase is spent then it must be true that the marginal propensity to consumer is relatively high.

j. In Keynesian analysis government spending refers only to the spending done by the federal level of government.

k. In equilibrium in the Keynesian model it must be true that total injections equal total leakages and that saving equal investment.

l. The size of planned consumption is influenced significantly by whether or not the federal government is running a deficit.

m. According to the Keynesian model, if foreign spending on U.S. goods increases this is likely to lead to increases in total output in the United States.

n. If unplanned inventories increase in the Keynesian model, production is likely to slow down.

o. If the economy is in equilibrium and suddenly the level of planned investment increases by $4 million dollars, national income will increase by $4 million.

p. The 45-degree line in the Keynesian income-expenditure model indicates the size of the marginal propensity to consume.

q. In the classical model a basic theoretical feature of self-regulating markets was that unsold inventory and unemployment in the labor market would cause prices and wages to increase.

r. In the simple Keynesian model if output exceeds aggregate expenditure then inventories will increase and businesses will raise prices.

s. In the Keynesian model businesses adjust their level of production to meet the demand for their product.

t. According to the Keynesian model, an increase in disposable income will increase both consumption and saving.

u. In the Keynesian model a given change in business investment will cause a larger change in equilibrium output.

v. The age and size of the existing capital stock helps to determine the level of planned investment.

w. Total planned consumption exceeds total income at very low levels of output.

x. Additional government spending that is undertaken to stabilize the economy is known as discretionary monetary policy.

y. If planned investment decreases, the multiplier will decrease the equilibrium income.

z. If taxes increase this will stimulate the economy.

2. Suppose you are given the following information about an economy.

C = 20 + .8(Y - T)
T = 10
G = 20
I = 20
(X - M) = 10

a. What is the y-intercept of the consumption function with respect to aggregate income?
b. What is the equilibrium level of income for this economy?
c. What is the saving function with respect to aggregate income for this economy?
d. At the equilibrium level of income leakages equal injections. What is the equilibrium level of saving in this economy?
e. What is the equilibrium level of consumption in this economy?
f. What is the multiplier for this economy?
g. What is the tax expenditure multiplier for this economy?
h. Suppose that this economy wishes to produce a level of output equal to $350. How much would government spending need to change by in order to reach this level of output? (Assume everything else stays constant.)

3. Suppose you are given the following information about an economy.

a. Fill in the first five columns of the table.

b. Fill in the savings column for this economy.

c. What is the marginal propensity to consume?

d. What is autonomous consumption with respect to disposable income equal to in this economy?

e. If you were to graph the consumption function with respect to aggregate income, what would be the y-intercept of the consumption function?

f. Using the above information, complete the following table.

g. What is the equilibrium level of output for this economy?

h. what is the equilibrium level of consumption for this economy when it is producing at the equilibrium level of output?

i. What is saving equal to at the equilibrium level of output?

Suppose the full employment level of output for this economy is $400.

j. At the equilibrium level of output is this a recessionary or a boom economy? Briefly explain your answer.

k. To reach the full employment level of output for this economy one could change government spending while holding all other autonomous variables constant. What would the change in government spending need to be in order to reach the full employment level of output for this economy?

l. To reach the full employment level of output for this economy one could change the level of taxes while holding all other autonomous variables constant. What would the change in taxes need to be in order to reach the full employment level of out put for this economy?

4. Suppose you are given the following information about an economy.

C = 10 + .5(Y - T)
T = 5 + .2Y
G = 10
I = 5
(X - M) = 5

a. What is the consumption function with respect to aggregate income?

b. What is the saving function with respect to disposable income?

c. What is the saving function with respect to aggregate income?

d. What is the equilibrium level of income for this economy?

e. What is the multiplier equal to for this economy?

f. What is the tax expenditure multiplier equal to for this economy?

5.

a. Fill in the following table (assume taxes are autonomous and independent of income).

b. Fill in the blanks:

The larger the MPS, the ______________________the multiplier.

The larger the MPC, the ______________________the multiplier.

c. When the MPC equals .75, an increase in government spending (holding everything else constant) of $100 will cause aggregate income to ____________________.

d. When the MPS equals .75, an increase in taxes of $250 will cause aggregate income to __________________________.

e. When the MPC equals .5, a simultaneous increase in government spending and taxes of $100 will cause aggregate income to _________________________.