Deck 11: Part A: The Aggregate Expenditures Model

Question 1

Evaluate the statement that "for an open economy the equilibrium GDP always corresponds with an equality of exports and imports."

Answer 1

This statement would be true only by coincidence, if ever.Equilibrium GDP (in the absence of government) occurs where aggregate expenditures equal real GDP.Aggregate expenditures consist of three components: C, Ig, and net exports.There is no reason why net exports must equal zero.The only requirement is that the sum of the three components, C, Ig, and (X-M ) sum to the same value as real GDP.At that point GDP will be in equilibrium.C or Ig or X or M or any or all of these can adjust in a situation where disequilibrium exists, but equilibrium doesn't necessitate net exports of zero.

Question 2

What is the relationship between actual investment, planned investment, and saving in an economy? What conditions among these concepts produce equilibrium?

Answer 2

Actual investment consists of both planned and unplanned changes in inventories.It equals saving by definition.Unplanned changes in inventories, however, are the item that helps equate actual investment with saving.Thus, planned investment and saving will only be equal when there are no unplanned changes in inventories.Equilibrium occurs in the economy only when planned investment equals saving.

Question 3

What differentiates the planned equilibrium level of investment from disequilibrium levels of investment? Explain.

Answer 3

Planned investment differs from unplanned investment by the changes in inventories.If inventories exceed the planned level, then producers will want to reduce output.If inventories are less than the planned level, then producers will want to expand output.Only when inventories are at the planned level will there be an equilibrium level of GDP.

Question 4

Whenever there is an upshift or downshift in aggregate expenditures due to a change in one of its non-income determinants, the equilibrium GDP changes by a multiple of the initial change in spending.Explain this multiplier effect.

Question 5

In addition to stuck prices, what are the two simplifying assumptions of the initial model in this chapter? What are two implications from these simplifications?

Question 6

How does the fact that imports vary directly with GDP affect the stability of the domestic economy?

Question 7

In a graph relating private spending (C + Ig) to real gross domestic product (GDP), what does the 45-degree line represent?

Question 8

Explain the difference between an equilibrium level of GDP and a level of GDP that is in disequilibrium.

Question 9

Use the graph below to explain the determination of equilibrium GDP by the aggregate expenditures-domestic output approach.At equilibrium C + Ig = Real GDP ($550 + $50 = $600).Why does the intersection of the aggregate expenditures schedule and the 45-degree line determine the equilibrium GDP?

Question 10

The aggregate expenditures model has one over-arching assumption.What is this assumption?

Question 11

Other things being constant, what will be the effect of each of the following upon the equilibrium level of GDP?
(a) An increase in the amount of liquid assets consumers are holding;
(b) A sharp rise in stock prices;
(c) A rapid upsurge in the rate of technological advance; and
(d) A sharp increase in the interest rate.

Question 12

What is the effect of net exports, either positive or negative, on equilibrium GDP?

Question 13

Explain why exports are added to, and imports are subtracted from, aggregate expenditures in moving from a closed to an open economy.

Question 14

Whenever there is a shift in the investment schedule and/or the consumption-saving schedules, there will be a new equilibrium level of GDP.Explain why this is so.

Question 15

Explain the difference between planned and actual investment in the economy.Why is the distinction important?

Question 16

If prices are stuck, how can firms receive feedback from the market to tell them how much to produce?

Question 17

Explain why saving equals planned investment at equilibrium GDP.

Question 18

Define the equilibrium level of output.

Question 19

What is the difference between the investment-demand curve and the investment schedule for the economy?

Question 20

What are two components of aggregate expenditures in a closed private economy?

Question 21

Explain the effect of an increase in government spending of $50 billion on the economy.Assume that investment, net exports, government expenditures, and taxes do not change with changes in real GDP and the MPC is .75.

Question 22

Why does the inclusion of a lump-sum tax cause domestic consumption to fall initially by an amount less than the tax?

Question 23

Compare and contrast the recessionary gap and the inflationary gap.

Question 24

If there is a recessionary gap of $100 billion and the MPC is 0.8, by how much must taxes be reduced to eliminate the recessionary gap? Assume that prices are stuck and that investment, net exports, government expenditures, and taxes do not change with changes in real GDP.

Question 25

At the current level of real GDP,
Sa = $180
Ig = $160
X = $300
M = $280
G = $250
T = $270
(a) What is the size of injections? Leakages?
(b) Is GDP at its equilibrium level? Explain.(c) What is the unplanned change in inventories? Explain.

Question 26

Assume the level of investment is $8 billion and independent of the level of total output.Complete the following table and answer the following questions about this private closed economy. (a) What are the sizes of the MPC, MPS, and multiplier in this economy?
(b) If full employment in this economy is 140 million, will there be a recessionary or inflationary gap? Explain the consequences of this gap.(c) Using the multiplier concept, determine what change in investment is needed to eliminate the output gap.(d) If full employment in this economy is 110 million, will there be an inflationary or recessionary gap? Explain the consequences of this gap.(e) Using the multiplier concept, determine what change in investment is needed to eliminate the output gap from part (d).

Question 27

Keynes developed his theory during the height of the Great Depression (a severe recessionary gap) in the 1930s.What two policy tools did he recommend to close this gap?

Question 28

Explain the relationship between net exports and the following factors: prosperity abroad, tariffs on Canadian exports abroad, depreciation of the Canadian dollar on foreign exchange markets.

Question 29

At the current level of real GDP,
Sa = $160
Ig = $180
X = $320
M = $280
G = $270
T = $240
(a) What is the size of injections? Leakages?
(b) Is GDP at its equilibrium level? Explain.(c) What is the unplanned change in inventories? Explain.

Question 30

Explain how the recession resulting from the financial crisis in the United States in late-2008 was transmitted to Canada.

Question 31

Explain the effect of a cut in lump-sum taxes of $40 billion on the economy.Assume that investment, net exports, government expenditures, and taxes do not change with changes in real GDP and the MPC is .75.How does the impact of this change differ from that of a $40 billion increase in government spending?

Question 32

When international trade is considered, explain how net exports could be either positive or negative additions to aggregate expenditures.In which case would the impact of net exports be expansionary? Explain.

Question 33

Assume that investment, net exports, government expenditures, and taxes do not change with changes in real GDP and the MPC is .75.(a) Suppose government spending increases by $20 billion.What is the impact on real GDP?
(b) Suppose that instead lump-sum taxes increase by $20 billion.What is the impact on real GDP?
(c) How would the results in (a) and (b) be different if imports and taxes increase as real GDP increases?

Question 34

Explain why are nations are tempted to use policies of imposing tariffs on imported goods, and devaluating their national currency? Further explain why implementing such policies are huge mistakes?

Question 35

The data in the first two columns below are for a closed economy without government.Use this table to answer the following questions. (a) What is the equilibrium GDP for the closed economy?
(b) What is the size of the multiplier in the closed economy?
(c) Including the international trade figures for exports and imports, calculate net exports and determine the equilibrium GDP for an open economy.(d) What will happen to equilibrium GDP if exports were $25 billion larger at each level of GDP?
(e) What is the size of the multiplier in the open economy?

Question 36

Some critics of the Chinese government accuse it of "manipulating" its currency, the Chinese yuan.Explain the nature of and the effects of this "manipulation".

Question 37

"If taxes and government spending are increased by the same amount, there will still be a positive effect on equilibrium GDP." Explain.

Question 38

The data in the first two columns below are for a closed economy without government.Use this table to answer the following questions. (a) What is the equilibrium GDP for the closed economy?
(b) What is the size of the multiplier in the closed economy?
(c) Including the international trade figures for exports and imports, calculate net exports and determine the equilibrium GDP for an open economy.(d) What will happen to equilibrium GDP if exports were $25 billion larger at each level of GDP?
(e) What is the size of the multiplier in the open economy?

Question 39

Describe the impact of an increase in government spending assuming no change in taxes and less than full-employment output.

Question 40

What is the difference between the multiplier in a closed private economy and the multiplier in a mixed open economy?

Question 41

Answer the following questions using the aggregate expenditures model of the economy described below.C = 100 + .8Yd
T = 60 + .25Y
Ia = 28
Ga = 48
Xa = 54
M = .1Y
(a) What are the marginal propensity to consume, the marginal tax rate, and the marginal propensity to import?
(b) What is the saving function? What is the marginal propensity to save?
(c) What is the aggregate expenditure function? What is autonomous expenditure? What is the marginal propensity to withdraw?
(d) What is the equilibrium level of real GDP?
(e) What is the size of the multiplier?
(f) Suppose the full employment level of real GDP is $380.Does a recessionary gap or an inflationary gap exist? How can the government eliminate the gap by altering government expenditures?

Question 42

Answer the following questions using the aggregate expenditures model of the economy described below.C = 80 + .6Yd
T = 40 + .2Y
Ia = 28
Ga = 64
Xa = 76
M = .18Y
(a) What are the marginal propensity to consume, the marginal tax rate, and the marginal propensity to import?
(b) What is the saving function? What is the marginal propensity to save?
(c) What is the aggregate expenditure function? What is autonomous expenditure? What is the marginal propensity to withdraw?
(d) What is the equilibrium level of real GDP?
(e) What is the size of the multiplier?
(f) Suppose the full employment level of real GDP is $340.Does a recessionary gap or an inflationary gap exist? How can the government eliminate the gap by altering government expenditures?

Question 43

Use the table below to answer the following questions.Assume that investment, net exports, government expenditures, and taxes do not change with changes in real GDP. (a) What is the size of the multiplier in this economy?
(b) If taxes are zero, government expenditures are $10, investment is $6, and net exports are zero, what is the equilibrium GDP?
(c) If taxes are $5, government expenditures are $10, investment is $6, and net exports are zero, what is the equilibrium GDP?
(d) Assume investment is $50, taxes are $50, net exports and government expenditures are each zero.The full-employment level of real GDP is $340.How much of a reduction in taxes is needed to eliminate the recessionary gap?
(e) Assume that investment, net exports, and taxes are zero.Government expenditures are $20 and the full-employment level of real GDP is $330.By how much must government spending be reduced to eliminate the inflationary gap?

Question 44

Refer to the following table to answer the questions. (a) Assuming that investment, net exports, government expenditures, and taxes do not change with changes in real GDP, what are the sizes of the MPC, the MPS, and the multiplier?
(b) If full employment in this economy is 65 million, will there be an inflationary or recessionary 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 or recessionary gap? Explain.(c) Will there be an inflationary or recessionary gap if the full-employment level of output is $250 billion? Explain the consequences.By how much would aggregate expenditures in column 3 have to change at each level of GDP to eliminate the inflationary or recessionary gap? Explain.

Question 45

Answer the following questions using the aggregate expenditures model of the economy described below.C = 90 + .7Yd
T = 50 + .2Y
Ia = 36
Ga = 45
Xa = 62
M = .16Y
(a) What are the marginal propensity to consume, the marginal tax rate, and the marginal propensity to import?
(b) What is the saving function? What is the marginal propensity to save?
(c) What is the aggregate expenditure function? What is autonomous expenditure? What is the marginal propensity to withdraw?
(d) What is the equilibrium level of real GDP?
(e) What is the size of the multiplier?
(f) Suppose the full employment level of real GDP is $350.Does a recessionary gap or an inflationary gap exist? How can the government eliminate the gap by altering government expenditures?

Question 46

Use the table below to answer the following questions.Assume that investment, net exports, government expenditures, and taxes do not change with changes in real GDP. (a) What is the size of the multiplier in this economy?
(b) If taxes are zero, government expenditures are $5, investment is $3, and net exports are zero, what is the equilibrium GDP?
(c) If taxes are $10, government expenditures are $10, investment is $6, and net exports are zero, what is the equilibrium GDP?
(d) Assume investment is $50, taxes are $50, and net exports and government expenditures are each zero.The full-employment level of real GDP is $540.How much of a reduction in taxes is needed to eliminate the recessionary gap?
(e) Assume that investment, net exports, and taxes are zero.Government expenditures are $10 and the full-employment level of real GDP is $530.By how much must government spending be reduced to eliminate the inflationary gap?

Question 47

Assume the level of investment is $12 billion and independent of the level of total output.Complete the following table and answer the following questions about this private closed economy. (a) What are the sizes of the MPC, MPS, and multiplier in this economy?
(b) If full employment in this economy is 110 million, will there be a recessionary or inflationary gap? Explain the consequences of this gap.(c) Using the multiplier concept, determine what change in investment is needed to eliminate the output gap.(d) If full employment in this economy is 80 million, will there be an inflationary or recessionary gap? Explain the consequences of this gap.(e) Using the multiplier concept, determine what change in investment is needed to eliminate the output gap from part (d).