Questions and Answers of Economics Principles and Policy

Suppose that a certain country has an MPC of .9 and a real GDP of $400 billion. If its investment spending decreases by $4 billion, what will be its new level of real GDP? LO3
By how much will GDP change if firms increase their investment by $8 billion and the MPC is .80? If the MPC is .67? LO3
Using the consumption and saving data in problem 1 and assuming investment is $16 billion, what are saving and planned investment at the $380 billion level of domestic output? What are saving and
Assuming the level of investment is $16 billion and independent of the level of total output, complete the table immediately below and determine the equilibrium levels of output and employment in
LAST WORD What is Say’s law? How does it relate to the view held by classical economists that the economy generally will operate at a position on its production possibilities curve (Chapter 1)? Use
What is a recessionary expenditure gap? An inflationary expenditure gap? Which is associated with a positive GDP gap? A negative GDP gap? LO5
Explain graphically the determination of equilibrium GDP for a private economy through the aggregate expenditures model. Now add government purchases (any amount you choose) to your graph, showing
Assuming the economy is operating below its potential output, what is the impact of an increase in net exports on real GDP? Why is it difficult, if not impossible, for a country to boost its net
Depict graphically the aggregate expenditures model for a private closed economy. Now show a decrease in the aggregate expenditures schedule and explain why the decline in real GDP in your diagram is
Other things equal, what effect will each of the following changes independently have on the equilibrium level of real GDP in the private closed economy? LO3a. A decline in the real interest rate.b.
Why is saving called a leakage ? Why is planned investment called an injection ? Why must saving equal planned investment at equilibrium GDP in the private closed economy?Are unplanned changes in
Why does equilibrium real GDP occur where C 1 I g 5 GDP in a private closed economy? What happens to real GDP when C 5 I g exceeds GDP? When C 5 I g is less than GDP?What two expenditure components
What is an investment schedule and how does it differ from an investment demand curve? LO1
The stuck-price assumption of the aggregate expenditures model is not credible when the economy approaches or attains its full-employment output. With unemployment low and excess production capacity
Keynes suggested that the solution to the large negative GDP gap that occurred during the Great Depression was for government to increase aggregate expenditures. It could do this by increasing its
The equilibrium GDP and the full-employment GDP may differ. A recessionary expenditure gap is the amount by which aggregate expenditures at the full-employment GDP fall short of those needed to
In the complete aggregate expenditures model, equilibrium GDP occurs where C a 1 I g 1 X n 1 G 5 GDP. At the equilibrium GDP, leakages of after-tax saving ( S a ), imports ( M ), and taxes ( T )
Taxation reduces disposable income, lowers consumption and saving, shifts the aggregate expenditures curve downward, and reduces equilibrium GDP.
Government purchases in the model of the mixed economy shift the aggregate expenditures schedule upward and raise GDP.
Positive net exports increase aggregate expenditures to a higher level than they would if the economy were “closed”to international trade. Negative net exports decrease aggregate expenditures
The net export schedule in the model of the open economy relates net exports (exports minus imports) to levels of real GDP. For simplicity, we assume that the level of net exports is the same at all
A shift in the investment schedule (caused by changes in expected rates of return or changes in interest rates) shifts the aggregate expenditures curve and causes a new equilibrium level of real GDP.
Actual investment consists of planned investment plus unplanned changes in inventories and is always equal to saving.
At equilibrium GDP, there are no unplanned changes in inventories. When aggregate expenditures diverge from real GDP, an unplanned change in inventories occurs. Unplanned increases in inventories are
At equilibrium GDP, the amount households save (leakages)and the amount businesses plan to invest (injections) are equal. Any excess of saving over planned investment will cause a shortage of total
For a private closed economy the equilibrium level of GDP occurs when aggregate expenditures and real output are equal or, graphically, where the C 1 I g line intersects the 45°line. At any GDP
The aggregate expenditures model views the total amount of spending in the economy as the primary factor determining the level of real GDP that the economy will produce. The model assumes that the
In the economy depicted, the $5 billion inflationary expenditure gap:a. expands real GDP to $530 billion.b. leaves real GDP at $510 billion but causes inflation.c. could be remedied by equal $5
The recessionary expenditure gap depicted will cause:a. demand-pull inflation.b. cost-push inflation.c. cyclical unemployment.d. frictional unemployment.
The inflationary expenditure gap depicted will cause:a. demand-pull inflation.b. cost-push inflation.c. cyclical unemployment.d. frictional unemployment.
In the economy depicted:a. the MPS is .50.b. the MPC is .75.c. the full-employment level of real GDP is $530 billion.d. nominal GDP always equals real GDP.
Tariffs and deliberate currency depreciations are unlikely to increase net exports, because other nations will retaliate.
In the open economy changes in (a) prosperity abroad,(b) tariffs, and (c) exchange rates can affect U.S. net exports and therefore U.S. aggregate expenditures and equilibrium GDP.
Negative net exports decrease aggregate expenditures relative to the closed economy and, other things equal, reduce equilibrium GDP.
Positive net exports increase aggregate expenditures relative to the closed economy and, other things equal, increase equilibrium GDP.
The $430 billion level of real GDP is not at equilibrium because:a. investment exceeds consumption.b. consumption exceeds investment.c. planned C 1 Ig exceeds real GDP.d. planned C 1 Ig is less than
The $490 billion level of real GDP is not at equilibrium because:a. investment exceeds consumption.b. consumption exceeds investment.c. planned C 1 Ig exceeds real GDP.d. planned C 1 Ig is less than
At all points on the 45° line:a. equilibrium GDP is possible.b. aggregate expenditures exceed real GDP.c. consumption exceeds investment.d. aggregate expenditures are less than real GDP.
In this figure, the slope of the aggregate expenditures schedule C 1 Ig:a. increases as real GDP increases.b. falls as real GDP increases.c. is constant and equals the MPC.d. is constant and equals
Identify and describe the nature and causes of“recessionary expenditure gaps” and “inflationary expenditure gaps.”
Explain how economists integrate the international sector (exports and imports) and the public sector(government expenditures and taxes) into the aggregate expenditures model.
Analyze how changes in equilibrium real GDP can occur in the aggregate expenditures model and describe how those changes relate to the multiplier.
Discuss the three characteristics of the equilibrium level of real GDP in a private closed economy:aggregate expenditures 5 output; saving 5 investment; and no unplanned changes in inventories.
Illustrate how economists combine consumption and investment to depict an aggregate expenditures schedule for a private closed economy.
Suppose that an initial $10 billion increase in investment spending expands GDP by $10 billion in the first round of the multiplier process. If GDP and consumption both rise by$6 billion in the
What will the multiplier be when the MPS is 0, .4, .6, and 1?What will it be when the MPC is 1, .90, .67, .50, and 0?How much of a change in GDP will result if firms increase their level of
Refer to the table in Figure 27.5 and suppose that the real interest rate is 6 percent. Next, assume that some factor changes such that the expected rate of return declines by 2 percentage points at
Assume there are no investment projects in the economy that yield an expected rate of return of 25 percent or more. But suppose there are $10 billion of investment projects yielding expected returns
Suppose a handbill publisher can buy a new duplicating machine for $500 and the duplicator has a 1-year life. The machine is expected to contribute $550 to the year’s net revenue. What is the
Use your completed table for problem 1 to solve this problem.Suppose the wealth effect is such that $10 changes in wealth produce $1 changes in consumption at each level of income. If real estate
ADVANCED ANALYSIS Linear equations for the consumption and saving schedules take the general form C 5 a 1 bY and S 5 2 a 1 (1 2 b ) Y , where C , S , and Y are consumption, saving, and national
ADVANCED ANALYSIS Suppose that the linear equation for consumption in a hypothetical economy is C 5 40 1.8 Y . Also suppose that income ( Y ) is $400. Determine( a ) the marginal propensity to
Suppose that disposable income, consumption, and saving in some country are $200 billion, $150 billion, and $50 billion, respectively. Next, assume that disposable income increases by $20 billion,
Refer to the table below. LO1a. Fill in the missing numbers in the table.b. What is the break-even level of income in the table?What is the term that economists use for the saving situation shown at
LAST WORD What is the central economic idea humorously illustrated in Art Buchwald’s piece, “Squaring the Economic Circle”? How does the central idea relate to economic recessions, on the one
Why is the actual multiplier in the U.S. economy less than the multiplier in this chapter’s example? LO5
Is the relationship between changes in spending and changes in real GDP in the multiplier effect a direct (positive)relationship or is it an inverse (negative) relationship?How does the size of the
Why is investment spending unstable? LO4
How is it possible for investment spending to increase even in a period in which the real interest rate rises? LO4
In what direction will each of the following occurrences shift the investment demand curve, other things equal? LO4a. An increase in unused production capacity occurs.b. Business taxes decline.c. The
Why will a reduction in the real interest rate increase investment spending, other things equal? LO3
Why does a downshift of the consumption schedule typically involve an equal upshift of the saving schedule? What is the exception to this relationship? LO2
In what direction will each of the following occurrences shift the consumption and saving schedules, other things equal? LO2a. A large decrease in real estate values, including private homes.b. A
Precisely how do the MPC and the APC differ? How does the MPC differ from the MPS? Why must the sum of the MPC and the MPS equal 1? LO1
What are the variables (the items measured on the axes) in a graph of the ( a ) consumption schedule and ( b ) saving schedule?Are the variables inversely (negatively) related or are they directly
Economists disagree on the size of the actual multiplier in the United States, with estimates ranging all the way from 2.5 to 0.But all estimates of actual-economy multipliers are less than the
The multiplier is equal to the reciprocal of the marginal propensity to save: The greater is the marginal propensity to save, the smaller is the multiplier. Also, the greater is the marginal
Through the multiplier effect, an increase in investment spending (or consumption spending, government purchases, or net export spending) ripples through the economy, ultimately creating a magnified
The durability of capital goods, the irregular occurrence of major innovations, profit volatility, and the variability of expectations all contribute to the instability of investment spending.
Either changes in interest rates or shifts of the investment demand curve can change the level of investment.
Shifts of the investment demand curve can occur as the result of changes in (a) the acquisition, maintenance, and operating costs of capital goods; (b) business taxes;(c) technology; (d) the stocks
The immediate determinants of investment are (a) the expected rate of return and (b) the real rate of interest.The economy’s investment demand curve is found by cumulating investment projects,
The locations of the consumption and saving schedules (as they relate to real GDP) are determined by (a) the amount of wealth owned by households, (b) expectations of future prices and incomes, (c)
The average propensities to consume and save show the fractions of any total income that are consumed and saved;APC 1 APS 51. The marginal propensities to consume and save show the fractions of any
Other things equal, a direct (positive) relationship exists between income and consumption and income and saving.The consumption and saving schedules show the various amounts that households intend
In this figure, investment will be:a. zero if the real interest rate is zero.b. $40 billion if the real interest rate is 16 percent.c. $30 billion if the real interest rate is 4 percent.d. $20
In this figure, if the real interest rate falls from 6 to 4 percent:a. investment will increase from 0 to $30 billion.b. investment will decrease by $5 billion.c. the expected rate of return will
In this figure:a. greater cumulative amounts of investment are associated with lower real interest rates.b. lesser cumulative amounts of investment are associated with lower expected rates of return
The investment demand curve:a. reflects a direct (positive) relationship between the real interest rate and investment.b. reflects an inverse (negative) relationship between the real interest rate
Illustrate how changes in investment increase or decrease real GDP by a multiple amount.
Identify and explain factors other than the real interest rate that can affect investment.
Explain how changes in real interest rates affect investment.
List and explain factors other than income that can affect consumption.
Describe how changes in income affect consumption (and saving).
Suppose that the nominal rate of inflation is 4 percent and the inflation premium is 2 percent. What is the real interest rate? Alternatively, assume that the real interest rate is 1 percent and the
If your nominal income rose by 5.3 percent and the price level rose by 3.8 percent in some year, by what percentage would your real income (approximately) increase? If your nominal income rose by 2.8
How long would it take for the price level to double if inflation persisted at ( a ) 2 percent per year, ( b ) 5 percent per year, and ( c ) 10 percent per year? LO3
If the CPI was 110 last year and is 121 this year, what is this year’s rate of inflation? In contrast, suppose that the CPI was 110 last year and is 108 this year. What is this year’s rate of
Suppose that the natural rate of unemployment in a particular year is 5 percent and the actual rate of unemployment is 9 percent. Use Okun’s law to determine the size of the GDP gap in
Assume the following data for a country: total population, 500; population under 16 years of age or institutionalized, 120; not in labor force, 150; unemployed, 23; parttime workers looking for
Suppose that a country’s annual growth rates were 5, 3, 4, 21, 22, 2, 3, 4, 6, and 3 in yearly sequence over a 10-year period. What was the country’s trend rate of growth over this period? Which
LAST WORD Suppose that stock prices were to fall by 10 percent in the stock market. All else equal, would the lower stock prices be likely to cause a recession? How might lower stock prices help
Explain how hyperinflation might lead to a severe decline in total output. LO3
Explain how an increase in your nominal income and a decrease in your real income might occur simultaneously.Who loses from inflation? Who gains? LO3
Distinguish between demand-pull inflation and cost-push inflation. Which of the two types is most likely to be associated with a negative GDP gap? Which with a positive GDP gap, in which actual GDP
What is the Consumer Price Index (CPI) and how is it determined each month? How does the Bureau of Labor Statistics calculate the rate of inflation from one year to the next? What effect does
Because the United States has an unemployment compensation program that provides income for those out of work, why should we worry about unemployment? LO2
Why is it difficult to distinguish between frictional, structural, and cyclical unemployment? Why is unemployment an economic problem? What are the consequences of a negative GDP gap? What are the
How, in general, do unemployment rates vary by race and ethnicity, gender, occupation, and education? Why does the average length of time people are unemployed rise during a recession? LO2
How is the labor force defined and who measures it? How is the unemployment rate calculated? Does an increase in the unemployment rate necessarily mean a decline in the size of the labor force? Why

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