Practice Questions 4-
I. True/False and explain:
1. During recessions output decreases and is usually below potential GDP.
2. The unemployment rate rises during recessions and falls during expansions.
3. Shifts in the labor supply and/or the labor demand curves are the best explanation for economic fluctuations.
4. One assumption of the long run Classical model is that the labor market is always in disequilibrium.
5. During a recession wages are above the equilibrium wage.
6. Disequilibrium in the labor market is the reason why booms cannot last forever.
7. Economic fluctuations are caused by spending shocks.
8. When a shock causes a recession, firms (temporarily) operate at below-normal rates of utilization.
9. With the short-run macro model we are trying to explain changes in output with changes in total spending.
10. The consumption function is the same as the Consumption - Income line.
11. The slope of the consumption function, the marginal propensity to consume, is more than one.
12. If there is a decrease in autonomous taxes T, then there will be a change in the slope of the Consumption - Income line.
13. If there is a change in autonomous consumption, then there will be a shift in the Consumption - Income line.
14. Government spending and Investment are independent of income in the short-run model if they are autonomous.
15. If aggregate expenditure is larger than GDP, then we expect GDP to decrease in the future.
16. If an economy is in short run equilibrium, this implies that the economy is producing at full employment.
17. If firms decide to invest more, then GDP will increase in exactly the same amount.
18. Compare two different economies, A and B. If economy A's marginal propensity to consume (MPC) is larger than economy B's MPC, then that means that economy A has a smaller expenditure multiplier than does economy B.
19. Compare two different economies, A and B. If economy A's MPC is larger than economy B's MPC, then it must be the case that economy A's tax expenditure multiplier is larger in absolute value than is economy B's tax expenditure multiplier.
20. Changes in planned investment, government purchases, net exports, or autonomous consumption, lead to a multiplier effect on GDP.
II. Short Answer Problem:
1. Let's think about an economy where
- C = a + b*YD
- YD = Y - T
- AE = C + IP + G + (X - M)
And
a= 100; b=0.6; T= 100; IP= 45, G= 80 and (X - M) = 35.
Then-
What is the equilibrium level of output?
What is the marginal propensity to save?
What is the expenditure multiplier?
What is the equilibrium level of output if G= 100?
What is the tax expenditure multiplier?
If AE is 550, then what is the change in inventories?
In order to get a new equilibrium level of output at 650, what must the change in autonomous taxes be equal to?
2. Suppose we want to compare the effect of a tax cut in the economy given in the first problem to the effect of the same size tax cut on an economy with a MPC of 0.8. If everything else about these two economies is the same (except for their MPCs), then which one will experiences a larger change in GDP as a consequence of the tax cut? How much larger is the change in GDP?