Deck 11: Expenditure Multipliers: the Keynesian Model

Question 1

Use the following figure to work Problem.
The figure illustrates the components of aggregate planned expenditure on Turtle Island. Turtle Island has no imports or exports, no incomes taxes, and the price level is fixed.
Calculate autonomous expenditure and the marginal propensity to consume.

Answer 1

Autonomous expenditure refers to summation of investment and government expenditure. In addition, consumption expenditure might have an autonomous portion in it.
In other words, we can say that autonomous expenditure is that expenditure which a country incurs when GDP is zero. It means autonomous expenditure is that part of the aggregate expenditure, which does not depend on GDP.
The components of aggregate planned expenditure of Turtle Island are given below:
Here autonomous expenditure is $ 2 billion as it is the summation of investment and government expenditure. This is because, the autonomous consumption expenditure is zero here, and investment and government expenditure add up to $ 2 billion.
We know that marginal propensity to consume can be obtained by dividing the change in consumption expenditure by change in the disposable income.
Where:
• MPC=Marginal propensity to consume
•
=Change in consumption expenditure
•
Change in disposable income
Now, substitute the values in the formula:
Here marginal propensity to consume is 0.60.

Question 2

Use the following news clip to work Problem.
Consumer Growth Could Buoy China's Economy
Annual double-digit wage growth since 2000 has created a Chinese middle class ready to spend. And spend they have. Spending by China's consumers has grown at double-digit rates for a decade. Digital Luxury Group, a Geneva-based market researcher, reports that Chinese travelers made 70 million overseas trips in 2011 to places that include Bali, Dubai, Paris, London, Singapore, and Hong Kong. To cope with all this extra travel, China plans to build 56 new airports before the end of 2016. China's wealthy consumers in aggregate are poised to spend more on luxury goods than consumers in Japan and the United States.
Explain how China's real GDP is influenced by an increase in overseas travel and vacations.

Answer 2

Tourist and real GDP:
Increase in consumption expenditure will increase the aggregate demand and cause the price level to increase. At a higher price level aggregate supply will increase; hence, there will be more employment opportunities in the market. The increase in employment rate will increase the income level of the people, which, in turn, increase the aggregate demand. Therefore, consumption expenditure will have a multiplier effect on real GDP.
As more number of tourists visited abroad, the capital outflow from China has increased. Hence, the aggregate demand in domestic economy will fall and cause the price level to fall. As a result, aggregate supply will reduce and increase the unemployment rate. Increase in unemployment rate will reduce the income level, in turn, aggregate demand will fall.
Hence, the overseas travel and vacations influenced the real GDP of China.

Question 3

Use the following news clip to work Problem.
Consumer Sentiment in U.S. Rose to Three-Month High
Consumer sentiment was up in August helped by merchant discounts, especially from auto dealerships who received incentives from automakers Honda, General Motors, and Toyota to lower prices.
But consumers are worried about the future. They are worried about tax changes and government budget cuts that are on the horizon. Capital spending fell somewhat.
Explain and draw a graph to illustrate how increasing consumer confidence influences aggregate expenditure and aggregate demand.

Answer 3

Consumer's confident:
If people realized that their income will increase in near future, then they will be confident that they will be able to pay the current spending in future. As a result, consumption expenditure will increase. Hence, increase in consumer's confidence will increase the aggregate demand.
Increase in consumers' confidence will increase the aggregate demand and would cause the aggregate demand curve to shift outward from
to
. Hence, the demand for real GDP will increase from
to
.
Figure 1 shows the change in aggregate demand.
Figure 1
In Figure 1, real GDP is measured on the horizontal axis and price is measured on the vertical axis.

Question 4

Use the following figure to work Problem.
The figure illustrates the components of aggregate planned expenditure on Turtle Island. Turtle Island has no imports or exports, no incomes taxes, and the price level is fixed.
a. What is aggregate planned expenditure when real GDP is $6 billion?
b. If real GDP is $4 billion, what is happening to inventories
c. If real GDP is $6 billion, what is happening to inventories

Question 5

Use the following news clip to work Problem.
Consumer Growth Could Buoy China's Economy
Annual double-digit wage growth since 2000 has created a Chinese middle class ready to spend. And spend they have. Spending by China's consumers has grown at double-digit rates for a decade. Digital Luxury Group, a Geneva-based market researcher, reports that Chinese travelers made 70 million overseas trips in 2011 to places that include Bali, Dubai, Paris, London, Singapore, and Hong Kong. To cope with all this extra travel, China plans to build 56 new airports before the end of 2016. China's wealthy consumers in aggregate are poised to spend more on luxury goods than consumers in Japan and the United States.
Explain how China's consumption expenditure influences real GDP in the countries to which Chinese tourists travel in the short run and the long run.

Question 6

Mathematical Note
In an economy autonomous spending is $20 trillion and the slope of the AE curve is 0.6.
a. What is the equation of the AE curve?
b. Calculate equilibrium expenditure.
c. Calculate the multiplier if the price level is unchanged.

Question 7

Explain the difference between induced consumption expenditure and autonomous consumption expenditure. Why isn't all consumption expenditure induced expenditure?

Question 8

In the Canadian economy, autonomous consumption expenditure is $50 billion, investment is $200 billion, and government expenditure is $250 billion. The marginal propensity to consume is 0.7 and net taxes are $250 billion. Exports are $500 billion and imports are $450 billion. Assume that net taxes and imports are autonomous and the price level is fixed.
a. What is the consumption function?
b. What is the equation of the AE curve
c. Calculate equilibrium expenditure.
d. Calculate the multiplier.
e. If investment decreases to $150 billion, what is the change in equilibrium expenditure
f. Describe the process in part (e) that moves the economy to its new equilibrium expenditure.

Question 9

Recovery
In the second quarter, businesses increased spending on equipment and software by 21.9%, while a category that includes home building grew amid a rush by consumers to take advantage of tax credits for homes.
Explain how an increase in business investment at a constant price level changes equilibrium expenditure.

Question 10

Fixed Prices and Expenditure Plans
Use the following data to work Problem. You are given the following information about the economy of Australia.
Calculate the marginal propensity to save.

Question 11

Use the following data to work Problem.
An economy has a fixed price level, no imports, and no income taxes. MPC is 0.80, and real GDP is $150 billion. Businesses increase investment by $5 billion.
Calculate the multiplier and the change in real GDP.

Question 12

Fixed Prices and Expenditure Plans
Use the following data to work Problem. You are given the following information about the economy of Australia.
Calculate consumption at each level of disposable income. Calculate the marginal propensity to consume.

Question 13

Use the following data to work Problem.
An economy has a fixed price level, no imports, and no income taxes. MPC is 0.80, and real GDP is $150 billion. Businesses increase investment by $5 billion.
Calculate the new real GDP and explain why real GDP increases by more than $5 billion.

Question 14

Use the following news clip to work Problem.
Americans $2.4 trillion Poorer
The Federal Reserve reported that household wealth decreased by $2.4 trillion or $21,000 per household in the third quarter of 2011. This drop is the steepest since 2008 and the second consecutive quarterly drop. Foreclosures lowered household debt slightly but credit card debt increased. Many households are struggling to buy the essentials and spending on food has decreased. Separately, the Bureau of Economic Analysis reported that consumption expenditure increased by $39 billion in the third quarter of 2011.
Explain and draw a graph to illustrate how a fall in household wealth would be expected to influence the consumption function and saving function.

Question 15

Use the following data to work Problem.
An economy has a fixed price level, no imports, and no income taxes. An increase in autonomous expenditure of $2 trillion increases equilibrium expenditure by $8 trillion.
Calculate the multiplier and the marginal propensity to consume.

Question 16

Use the following news clip to work Problem.
Americans $2.4 trillion Poorer
The Federal Reserve reported that household wealth decreased by $2.4 trillion or $21,000 per household in the third quarter of 2011. This drop is the steepest since 2008 and the second consecutive quarterly drop. Foreclosures lowered household debt slightly but credit card debt increased. Many households are struggling to buy the essentials and spending on food has decreased. Separately, the Bureau of Economic Analysis reported that consumption expenditure increased by $39 billion in the third quarter of 2011.
What factors might explain the actual changes in consumption expenditure and wealth that occured in the third quarter of 2011?

Question 17

Use the following data to work Problem.
An economy has a fixed price level, no imports, and no income taxes. An increase in autonomous expenditure of $2 trillion increases equilibrium expenditure by $8 trillion.
What happens to the multiplier if an income tax is introduced?

Question 18

Use the following news clip to work Problem.
Americans $2.4 trillion Poorer
The Federal Reserve reported that household wealth decreased by $2.4 trillion or $21,000 per household in the third quarter of 2011. This drop is the steepest since 2008 and the second consecutive quarterly drop. Foreclosures lowered household debt slightly but credit card debt increased. Many households are struggling to buy the essentials and spending on food has decreased. Separately, the Bureau of Economic Analysis reported that consumption expenditure increased by $39 billion in the third quarter of 2011.
Draw a graph of a consumption function and show at what points consumers were actually operating in the second and third quarters. Make any necessary assumptions and explain your answer.

Question 19

Use the following data to work Problem.
Suppose that the economy is at full employment, the price level is 100, and the multiplier is 2. Investment increases by $100 billion.
What is the change in equilibrium expenditure if the price level remains at 100?

Question 20

Real GDP with a Fixed Price Level
Use the following spreadsheet, which lists real GDP (Y) and the components of aggregate planned expenditure in billions of dollars, to work Problem.

Calculate autonomous expenditure. Calculate the marginal propensity to consume.

Question 21

Use the following data to work Problem.
Suppose that the economy is at full employment, the price level is 100, and the multiplier is 2. Investment increases by $100 billion.
a. What is the immediate change in the quantity of real GDP demanded?
b. In the short run, does real GDP increase by more than, less than, or the same amount as the immediate change in the quantity of real GDP demanded

Question 22

Real GDP with a Fixed Price Level
Use the following spreadsheet, which lists real GDP (Y) and the components of aggregate planned expenditure in billions of dollars, to work Problem.

a. What is aggregate planned expenditure when real GDP is $200 billion?
b. If real GDP is $200 billion, explain the process that moves the economy toward equilibrium expenditure.
c. If real GDP is $500 billion, explain the process that moves the economy toward equilibrium expenditure.

Question 23

Use the following data to work Problem.
Suppose that the economy is at full employment, the price level is 100, and the multiplier is 2. Investment increases by $100 billion.
In the short run, does the price level remain at 100Explain why or why not.

Question 24

Real GDP with a Fixed Price Level
Wholesale Inventories Decline, Sales Rise
The Commerce Department reported that wholesale inventories fell 1.3 percent in August for a record 12th consecutive month, evidence that companies are trimming orders to factories, which helped depress economic output during the recession. Economists hope that the rising sales will encourage businesses to begin restocking their inventories, which would boost factory production and help bolster broad economic growth in coming months.
Explain why a fall in inventories is associated with recession and a restocking of inventories might bolster economic growth.

Question 25

Use the following data to work Problem.
Suppose that the economy is at full employment, the price level is 100, and the multiplier is 2. Investment increases by $100 billion.
a. In the long run, does real GDP increase by more than, less than, or the same amount as the immediate increase in the quantity of real GDP demanded?
b. Explain how the price level changes in the long run.

Question 26

The Multiplier
Obama's New Stimulus
The Obama recovery plan announced on Monday includes proposed spending of $50 billion to rebuild 150,000 miles of roads, construct and maintain 4,000 miles of rail, and fix or rebuild 150 miles of runways.
If the slope of the AE curve is 0.7, calculate the immediate change in aggregate planned expenditure and the change in real GDP in the short run if the price level remains unchanged.

Question 27

Use the following data to work Problem.
Suppose that the economy is at full employment, the price level is 100, and the multiplier is 2. Investment increases by $100 billion.
Are the values of the multipliers in the short run and the long run larger or smaller than 2?

Question 28

The Multiplier
Obama's Economic Recovery Plan
President Obama's proposal to jolt a listless recovery with $180 billion worth of tax breaks and transportation projects left economists largely unimpressed Tuesday.
If taxes fall by $90 billion and the spending on transport projects increases by $90 billion, which component of Obama's recovery plan would have the larger effect on equilibrium expenditure, other things remaining the same?

Question 29

Use the following data to work Problem. You are given the following information about the economy of the United Kingdom.
Calculate the marginal propensity to consume.

Question 30

Use the following news clip to work Problem.
The New New Deal
Remember what was actually in the stimulus bill of 2009: slightly more than $600 billion went toward poor and middle-class tax cuts, safety net spending (more unemployment assistance and food stamps), and aid to state governments with budget shortfalls. These are the most directly stimulative parts of the bill, bolstering demand and preventing lay-offs- and stimulate they did. Economists of differing ideological stripes generally agree that the economy would have as many as 3 million fewer jobs now were it not for the stimulus. The remaining sixth of the bill focused on longer-term investments, which included putting $90 billion into green energy.
Did the $600 billion of spending described above increase aggregate expenditure by more than, less than, or exactly $600 billionExplain.

Question 31

The Multiplier and the Price Level
Price Jump Worst Since '91
The biggest annual jump in the CPI since 1991 has fanned fears about growing pressures on consumers. The Labor Department report confirms what every consumer in America has known for months: Inflation is soaring and it's having an adverse impact on the economy.
Explain and draw a graph to illustrate the effect of a rise in the price level on equilibrium expenditure.

Question 32

Use the following data to work Problem. You are given the following information about the economy of the United Kingdom.
Calculate saving at each level of disposable income and calculate the marginal propensity to save.

Question 33

Use the following news clip to work Problem.
The New New Deal
Remember what was actually in the stimulus bill of 2009: slightly more than $600 billion went toward poor and middle-class tax cuts, safety net spending (more unemployment assistance and food stamps), and aid to state governments with budget shortfalls. These are the most directly stimulative parts of the bill, bolstering demand and preventing lay-offs- and stimulate they did. Economists of differing ideological stripes generally agree that the economy would have as many as 3 million fewer jobs now were it not for the stimulus. The remaining sixth of the bill focused on longer-term investments, which included putting $90 billion into green energy.
Explain and draw a graph to illustrate how this fiscal stimulus will influence aggregate expenditure and aggregate demand in both the short run and the long run.

Question 34

Use the following news clip to work Problem.
Consumer Sentiment in U.S. Rose to Three-Month High
Consumer sentiment was up in August helped by merchant discounts, especially from auto dealerships who received incentives from automakers Honda, General Motors, and Toyota to lower prices.
But consumers are worried about the future. They are worried about tax changes and government budget cuts that are on the horizon. Capital spending fell somewhat.
Which of the expenditures listed in the news clip are part of induced expenditure and which is part of autonomous expenditure?

Question 35

Collapsing Savings Rate
Before 1984, the U.S. savings rate held steady for decades, though it dipped during the Great Depression and rose sharply during WWII, when there was little to buy besides war bonds. The rate dipped briefly again after WWII, and then rose steadily until 1984, when saving was 10.2 percent of income. Since 1984, saving has fallen to between 2 percent and 3 percent of income.
Compare the MPC and MPS in the United States at different dates. Why might they differ?

Question 36

Use the following news clip to work Problem.
Consumer Growth Could Buoy China's Economy
Annual double-digit wage growth since 2000 has created a Chinese middle class ready to spend. And spend they have. Spending by China's consumers has grown at double-digit rates for a decade. Digital Luxury Group, a Geneva-based market researcher, reports that Chinese travelers made 70 million overseas trips in 2011 to places that include Bali, Dubai, Paris, London, Singapore, and Hong Kong. To cope with all this extra travel, China plans to build 56 new airports before the end of 2016. China's wealthy consumers in aggregate are poised to spend more on luxury goods than consumers in Japan and the United States.
Explain and draw a graph to illustrate the changes in autonomous expenditure and induced expenditure and the multiplier process at work in the above story.

Question 37

Use the following news clip to work Problem.
Consumer Sentiment in U.S. Rose to Three-Month High
Consumer sentiment was up in August helped by merchant discounts, especially from auto dealerships who received incentives from automakers Honda, General Motors, and Toyota to lower prices.
But consumers are worried about the future. They are worried about tax changes and government budget cuts that are on the horizon. Capital spending fell somewhat.
Which of the events reported in the news clip would change aggregate demand and which would change the quantity of real GDP demandedProvide a graphical illustration of the distinction.