TEST2-REVIEW(2) EXERCISES

1. What are the three factors explaining the inverse shape of the AD curve?
Interest rate effect, Foreign Ex effect, Real wealth effect
2. Explain the characteristics of the three ranges of the aggregate Supply curve
Keynesian range= Low fixed price and low output, Intermediate range=Increased
output and increased price, Classical range= maximum fixed output and
increased price.
3. Explain how the government can use monetary and fiscal policies to combat a)
inflation; b) unemployment.
Monetary: For inflation increase interest rate, for unemployment decrease
interest rate.
Fiscal: for Inflation increase taxes and reduce G, for unemployment decrease
taxes and increase G
4. Discuss the basic argument of supply-side economists.
Stimulate the economy by manipulatinf AS rather than AD. Cutting taxes as an
incentive is the main tool.

5. Consider the table of aggregates below:

Price Level Output AD +20 Output AS+20
Demanded Supplied
(millions) (millions)
92 80 100 20 40
96 70 90 30 50
100 60 80 40 60
104 50 70 50 70
108 40 60 60 80
112 30 50 70 90
116 20 40 80 100
120 10 30 90 110
a. Suppose the quantity of real output demanded increases by $20 million at
each and every price level, while the aggregate supply remains unchanged.
What would the equilibrium point be in that case (price and Output)?
Originally equilibrium is at price 104 and output of 50 (yellow) Price increase
from 104 to 108 Output increase from 50 to 60 (green),
b. What would be the effect if the supply-side economics is adopted with an
increase of $20 million in output supplied at each and every price level? Price
decrease from 104 to 100, output increase from 50 to 60 (blue)

6. Assume that an economy is operating in the intermediate range of the aggregate

supply curve. Use diagrams to show the effect of each of the following on the
economy’s output and price level:
a. Firms increase their investment spending AD increase: higher output AND
price
b. A tax cut increases disposable income AD increase: higher output AND price
c. A natural disaster hurts production AS decrease: Lower output AND higher
price
 d. A technological innovation improves efficiency in production AS increase:
Higher output AND lower price

e. Canadian exports increase by 4% AD right (increase)…

f. The Canadian dollar gains 3% in relative value. AD decrease….
g. Expectation of a recession among consumers AD decrease
h. A 1% increase in interest rate AD decreases
i. The expectation of rapid inflation AD increase
j. Increase in productivity AS increase

7. Under what circumstances would you advocate the following:

a. A contractionary (increase tax and higher interest) demand policy To fight
Inflation
b. An expansionary (decrease tax and lower interest) demand policy To fight
Unemployment

8. Supply-side economists support tax cuts as a mean of providing incentive to

work. Indicate on the Laffer curve the situation assumed by supply-side
economists.
The right side (downward sloping) of the Laffer curve shows that a tax cut
will in fact increase tax revenue. More productivity because of increase of
incentives to work and produce.

Presentation 8 and9_ AE/AO and the multiplier

1. Explain dissaving. In the case of dissaving what would be the value of

APC? Refers to negative saving (borrowing) or when C is higher that Y,
APC =C/Y would be higher than 1

2. What is the difference between APC and MPC?

APC refers to the consumption as a proportion of income whereas MPC
refers to the CHANGE of CONSUMPTION as a proportion of a change of
income ΔC/ΔY
3. Why is it that MPC + MPS = 1 always?
Because Y=C+S, what is not spent is saved.
4. List and explain injections and withdrawals Injections are all amounts that
increase the AE stream: I, G, X, Withdrawals are all amounts leaking out
of the AE stream: S, T, M
5. Complete the table below; then

a. calculate the slope of the consumption curve determine the C

function. C=a+0.6Y; 300=a+(0.75x300) = a + 180; a 300-180=120
therefore C=120+0.6Y
 INCOME CONSUMPTION APC APS MPC MPS
200 240 240/200=1.2 -0.2
300 300 1 0 60/100=0.6 0.4
400 360 0.9 0.1 0.6 0.4
500 420 0.84 0.16 0.6 0.4
600 480 0.8 0.2 0.6 0.4

6. Calculate
a) The MPC (marginal propensity to consume) knowing that the total income
increased from $400 million to $580 million and consumption changed from $300
million to $435 million MPC=ΔC/ΔY = 135/180=0.75
b) What is the MPS? 1-0.75=0.25
7. If the total income increased by $1200 million, determine the increase in
consumption given that the marginal propensity to save is 0.25

ΔY=1200; MPS=0.25; MPC=0.75…..ΔC/ΔY=

ΔC/ 1200………..ΔC/1200=0.75…….ΔC=0.75x1200=900

8. If the total increase in consumption is $ 500 million, determine the

increase in income given that the marginal propensity to save is 0.4
ΔC=500….. ΔY=?.....MPC=0.6 = ΔC/ ΔY= 500/ ΔY…… ΔY= 500/0.6 ==833.3

9. You are given the following consumption equation: C = 12 + 0.75 Y

a. What is the MPC 0.75
b. What is the MPS 0.25
c. What is the autonomous consumption? 12
d. What is the induced Consumption? 0.75Y
e. What is the equilibrium income Ye? aut/MPS=12/0.25= 48
f. If we inject an investment (I) is 10, what will the new autonomous
expenditure? 22
g. What is the multiplier? 1/.025 =4
h. What is the new equilibrium income Ye? 22/0.25=88

2. If the consumption function is given by the equation C= 10 + 0.8Y.

a. What is the MPS?0.2
b. Determine Ye aut/MPS=10/0.2=50
c. Calculate the multiplier 1/0.2=5
d. Add an Investment of 5 then redetermine Ye. Explain the increase
in Ye and its relation to the multiplier. 15/0.2=75..increase Ye by
25= multiplier x I =5x5

3. If the MPS of an economy is 0.25 and autonomous expenditure = 45,

a. What is the equilibrium level of income?45/0.25=180
 b. What should be the investment that will increase Y e by 120
K=1/MPS =1/0.25=4……….. ΔYe=IxK….120=Ix4…..I=120/4=30

4. Determine MPC if an investment of 60 increased Y e by 150

K=1/MPS = 150/60=2.5…………….MPS=1/2.5=0.4….MPC=0.6

5. Determine the autonomous Expenditure if MPC is 0.875 and Y e is 400

Autonomous/MPS= Ye =400….. Ye x MPS= auto=400 x 0.125 =50

6. Consider the following consumption equation: C = 40 + 0.75Y and

autonomous I = 4
a. Complete the following table

Y C I AE = C+I
50 40+(0.75x50)=77. 4 81.5
5
60 85 4 89
70 92.5 4 96.5
80 100 4 104
90 107.5 4 111.5
100 115 4 119

b. Determine the AE equation AE=44+0.75Y

c. Determine the equilibrium level of income (mathematically).

Ye = autonomous/MPS = 44/0.25=176

7. The table below represents a simple AE/AO model: a) Complete the table
and determine the AE equation AE=15+0.75Y
a. The equilibrium level of income (Ye). 15/0.25 = 60

Y (income) AE MPC MPS

0 15 MPC=ΔC/ ΔY 1-MPC
20 30 (30-15)/(20-0)=0.75 0.25
40 45 0.75 0.25
60 60 0.75 0.25
80 75 0.75 0.25
b) Add an investment I = 6 to AE and determine the new AE and the new
equilibrium level of income (Ye). AE2= 21 + 0.75; Ye2 = 21/0.25=84

Y (income) AE1 I AE2

0 15 6 21
20 30 6 36
40 45 6 51
60 60 6 66
80 75 6 81

c) What is the relation between the new (Ye) and the multiplier?
Multiplier k = 1/MPS = 1/0.25 = 4; We injected 6 and Δ Ye increased
by 24 = (6 x 4) = (6 x k)