Professional Documents
Culture Documents
39
©2013 Pearson Education, Inc. Publishing as Prentice Hall
40 CHAPTER 5
3. Assume that b = .75 and autonomous investment increases by $500 billion. By how much
does equilibrium income increase? How much would this increase in investment increase
income if b = .80 instead?
With b=0.80, the multiplier is equal to 1/(1 – b)=4. Then, an increase in investment of $500
billion increases equilibrium income by $2 trillion. If b = .8 then the multiplier is 5 and
income would increase by $2.5 trillion.
4. Assume that the consumption function equals
Y=C + I + G
Y= 1000
C = a + bYD
C = 900
S = –a+(1 – b)YD
S = 100
Y = 1050
5. Discuss two fiscal policies that a government could adopt that would increase both interest
rates and aggregate income.
An increase in government spending financed with bonds or a decrease in taxes financed
with bonds would increase the budget deficit and drive up interest rates. These changes in
fiscal policy would also increase aggregate income.
6. Discuss the role of the price level and interest rates in the simple model of aggregate
demand developed in this chapter. How do Keynesians justify this behavior?
The price level and interest rates are fixed in this model. This is justified by the fact that this
model is focused on the very short-run and as a result can be treated as constant.
7. Assume that a government increases both government spending and taxes by $200 billion
so that the budget balance remains unchanged. What will happen to aggregate income?
Explain the intuition behind this result.
As a result of this balanced-budget fiscal policy, aggregate income will increase by $200
billion. The reason is that all of the $200 billion of government spending will go into the
multiplier process, increasing income. However, some of the $200 billion tax increase will
come from savings, so the actual fall in consumption will be less than $200 billion. As a
result, the positive effect of the increase in government spending outweighs the negative
effects of the tax increase.
8. a. Show the autonomous investment multiplier in the open-economy model.
1/(1 – b + v)
b. Show the autonomous investment multiplier in the closed-economy model.
1/(1 – b)
c. Which multiplier will be smaller? Explain the intuition behind this result.
The multiplier in the open-economy model will be smaller because some of the increase
in aggregate income will not be spend domestically but will go into purchasing imports.
9. Explain why the government spending multiplier is greater than the tax multiplier.
The reason has to do with the change in autonomous expenditures. If government spending
increases by $100, autonomous expenditures rise by the full $100. However, if taxes are
reduced by $100, some of this money is saved by households (depending upon the size of
the marginal propensity to consume) and autonomous expenditures do not rise by the full
$100, reducing the size of the multipler.
10. Consider an alternative version of the Keynesian model, where planned investment is also a
function of current income: I = d + e(Y-T). How would this change the autonomous
expenditure multiplier in the closed-economy Keynesian model. Explain the intuition.
The intuition here is that now investment is a function of current income, just as
consumption is a function of current income. As a result, e (the marginal propensity to
invest) is similar to the marginal propensity to consume, where 1 - b – e equals the marginal
propensity to save. The new autonomous expenditure multiplier is (1/(1-b-e)
12. Suppose that, for a given economy, investment were equal to 100, government spending
equaled 150, taxes equaled 90 and consumption were given by
C = 120 + 0.75YD.
a. What will be the level of equilibrium income?
b. What is the value of the government expenditure multiplier and the tax multiplier?
c. Now suppose that investment rose to 50 units. Find the new value of equilibrium
income
d. What is the formula for the autonomous investment multiplier? Use this formula to
calculate how much income will change with a 10 unit increase in investment. Does the
change in income you calculated in part (c) correspond with the change in income just
calculated?
13. Explain the Keynesian theory of aggregate demand. How does this Keynesian theory differ
from the classical theory of aggregate demand discussed in Chapter 4?
14. What is the role of aggregate supply in the Keynesian model? Is it important in the
determination of output? Why or why not?
15. Use the Keynesian diagram to illustrate the impact of an increase in the interest rate on
equilibrium income. How will the change in income change as the elasticity of investment
demand changes?
16. Suppose that the MPC is 0.8 and the government was considering two possible fiscal
actions:
i. Raising government expenditures on goods and services by 10 units, and
ii. Raising lump-sum tax collections by 10 units.
a. What would be the effect on equilibrium GDP of policy (i) alone?
b. What would be the effect on equilibrium GDP of policy (ii) alone?
c. What would be the net effect on GDP of instituting both policies? Explain the economic
reason why you find this effect.
17. Consider an economy where C = 300 + 2/3(Y-T), Ir = 400, G = 250, and T = 220. Calculate
equilibrium income, private savings, and national savings.
18. Explain how the Keynesian model is a model of excess aggregate supply.
Multiple-Choice Questions
1. If the marginal propensity to consume is 0.8 and if government spending (G) rises by 50
while investment (I) falls by 20, by how much will equilibrium income rise?
a. 12
b. 10
c. 30
d. 120
e. 150*
2. If the government wishes to increase its spending on goods and services by $10 billion
without increasing the overall level of aggregate demand, it should
a. increase taxes by $10 billion.
b. decrease taxes by $10 billion.
c. increase taxes by more than $10 billion.*
d. increase taxes, but by less than $10 billion.
e. leave tax receipts unchanged.
3. The short-run refers to a period
a. of a few days.
b. when prices and wages cannot fully adjust.*
c. of a few years.
d. during which trend cannot change.
e. of analysis used in the classical model
4. In the simple Keynesian model, if there is an autonomous investment falls by $20 billion
and the MPC (b) is 0.60, the equilibrium income level will increase by
a. $13.3 billion.
b. $20 billion.
c. $50 billion.*
d. $100 billion.
5. In the equation Y = (1/1 – b + v)(a + I + G + X − u), the term (1/1 – b + v) is referred to as
the
a. level of autonomous expenditures.
b. autonomous expenditure multiplier.*
c. balanced budget multiplier.
d. tax multiplier.
6. Keynes believed that an important source of instability in the economy was instability
a. of private investment demand.
b. in the marginal propensity to consume (b).
c. of expectations.
d. in tax collections.
e. Both a and c*
7. In the Keynesian model, exogenous variables include
a. planned investment.
b. taxes.
c. planned inventories and government spending.
d. planned investment and government spending.
e. all of the above*
8. If the consumption function is given by C = 100 + .6(Y-T) and planned investment is 150,
government spending is 50, and T is 100, then equilibrium income is
a. 600*
b. 750
c. 400
d. 350
9. In the equation Y = C + I + G,
a. only I is an exogenous variable determined by factors outside the model.
b. only G is an exogenous variable determined by factors outside the model.
c. C is an endogenous variable determined by factors inside the model.*
d. I and G are exogenous variables determined by factors outside the model.
e. A, b, and c
10. If an increase in government spending of 40 units accompanied by an equal increase in
taxes caused equilibrium income to rise by 40 units, the autonomous expenditure multiplier
must be
a. 10.
b. 1.
c. 4.
d. not enough information is given to calculate the multiplier.*
11. If a fall in investment demand of 100 units causes equilibrium income to fall by 150 units in
the simple Keynesian model, then the marginal propensity to save must be
a. .25.
b. 1.5.
c. .5.
d. 1/3.*
e. 2/3.
12. Let C = 200 + .8(Y-T), planned investment equals 150, and T equals 200. If the equilibrium
level of income is 2,000, then the level of government spending needed to make this true is
a. 210.*
b. 250.
c. 50.
d. 10.
e. none of the above.
13. If the marginal propensity to save is equal to 0.5 in the simple Keynesian model, then a 10-
unit increase in government spending will cause output to rise by
a. 5 units.
b. 10 units.
c. 20 units.*
d. 25 units.
e. 40 units.
14. Compared to the closed economy Keynesian model, the open economy model in which
imports are a function of income has an investment multiplier that is
a. smaller.*
b. larger.
c. equal.
d. equal to 1.
15. In the simple Keynesian model (no money market) assume that equilibrium output falls
short of potential output by 300 units and the MPC = 0.8. The size of the tax cut needed to
reach full employment is
a. 30.
b. 60.
c. 75.*
d. 300.
16. Using the simple Keynesian model, consider the case where taxes are lump-sum. Compared
to the model without taxes, the investment multiplier in this model will
a. not change.*
b. be larger.
c. be smaller.
d. be equal to 1.
17. Which of the following are equilibrium conditions in the simple Keynesian model?
a. Ir = I
b. G = T
c. S + T = I + G
d. Y = C + I + G
e. A, c, and d*
18. Assuming that C + Ir + G < C + I + G, then
a. there is an unintended inventory accumulation.
b. there is an unintended inventory shortfall.
c. aggregate demand is less than output.
d. Both b and c*
19. In the Keynesian consumption function
a. consumption is a constant fraction of income.
b. the marginal propensity to consume is constant.
c. disposable income determines consumption.
d. All of the above*
e. None of the above
20. According to Keynes, the level of consumer expenditures was a stable function of
a. national income.
b. gross income.
c. disposable income.*
d. net income.
e. None of the above
21. Which of the following does not impact aggregate demand in the Keynesian model?
a. Changes in the supply of labor*
b. Net exports
c. Household consumption
d. Desired business investment demand
e. Government purchases of goods and services
37. In the simple Keynesian model, if the equilibrium level of income is $300 billion, the MPC
is 0.75, and government expenditures increase by 20 billion. What is the new equilibrium
level of income?
a. $320 billion
b. $380 billion*
c. $220 billion
d. $520 billion
38. Total planned expenditure is composed as
a. planned investment.
b. planned government spending and taxes.
c. total investment, total consumption, and government spending.
d. planned investment, planned government spending, and planned taxes.*
39. In the simple Keynesian model, equilibrium exists when
a. actual investment equals realized investment.
b. exports equal imports.
c. savings is equal to government spending plus desired investment minus taxes.*
d. national product is equal to consumption minus desired investment plus government
spending.
e. None of the above
40. Assuming that C + I + G > C + Ir + G, then
a. aggregate demand exceeds than output.
b. unplanned inventories are negative.
c. there is an unintended inventory accumulation.
d. Both a and c*
e. None of the above
41. According to Keynes, the least variable component of aggregate expenditures is
a. consumption.*
b. inventories.
c. total investment.
d. imports
42. Which of the following equations illustrates the equilibrium level of income with respect to
the simple Keynesian closed-economy model?
a. Y = [1/(1 − b)](a − bT − I + G)
b. Y = [1/(1 − b)](a + bT + I + G)
c. Y = [1/(1 + b)](a − bT − I − G)
d. Y = [1/(1 − b)](a − bT + I + G)*
e. Y = (1 − b)(a + bT + I + G)
43. In the open-economy Keynesian model, it always has to be true that
a. planned savings equals planned investment.
b. planned savings is greater than planned investment.
c. planned savings is less than planned investment.
d. none of the above.*
51. Within the simple Keynesian model with lump-sum taxes, if the MPC (b) were 0.75 then if
taxes rise by $200 then income
a. rises by $800.
b. falls by $200.
c. falls by $800.
d. rises by $200.
e. falls by $800.*
52. The equation for the balanced budget multiplier can be written as
a. (1/1 – b) – (b/1 – b).
b. (1/1 + b) + (− b/1 – b).
c. (1/1 – b) + (b/1 + b).*
d. (1/1 + b) – (b/1 + b).
53. If the government decreases spending and taxes by 1,000 units and the marginal propensity
to consume is .9, then
a. more information is needed.
b. output will decrease by 900.
c. output will decrease by 10,000.*
d. output will increase by 10,000.
54. In the Keynesian aggregate expenditure graph (Figure 5-5), the 45 degree line is meant to
indicate that:
a. planned aggregate expenditure always equals aggregate income.
b. savings must equal investment.
c. actual aggregate expenditure must equal aggregate income.*
d. actual income must equal planned income.
e. none of the above.
55. If the consumption function is C = 120 +_.8(Y-T) in the basic Keynesian model, then in the
government spending multiplier is:
a. 5.*
b. 4.
c. 1.25.
d. .8
56. Which of the following is FALSE?
a. As the interest rate falls, planned expenditure must be greater than actual expenditure.*
b. As the interest rate falls, planned expenditure rises.
c. As the interest rate falls, the IS curve shifts to the right.
d. As the interest rate falls, planned expenditure can be greater than actual expenditure.
57. At equilibrium income:
a. planned and actual expenditure are equal.
b. GDP will remained unchanged until an exogenous shock occurs.
c. unplanned inventories are equal to zero.
d. all of the above.*