MODULE 21 _ Review Check Your Understanding 1. Explain why a $500 million increase in government purchases of goods and services will generate a larger rise in real GDP than a $500 million increase in govern- ment transfers. . Explain why the tax multiplier is smaller than the spending multiplier for a decrease in government purchases. 3. The country of Boldovia has no unemployment insurance benets and a tax system that uses only lump-sum taxes. The neighboring country of Moldovia has generous unem- ployment benets and a tax system in which residents must pay a percentage of their income. Which country will experience greater variation in real GDP in response to demand Shocks, positive and negative? Explain. Tackle the Test: Multiple-Choice Questions 'I. The marginal propensity to consume I. has a negative relationship to the spending multiplier. is equal to 1. represents the proportion of consumers' dispos able income that is spent. u. I only I). II only c. III only (I. I and III only a. I, II, and III 2. Assume that taxes and interest rates remain unchanged when government spending increases, and that both savings and consumer spending increase when income increases. The ultimate effect on real GDP of a $100 million increase in government purchases of goods and services will be a. an increase of $100 million. an increase of more than $100 million. . an increase of less than $100 million. . an increase ofeither more than or less than $100 million, depending on the MPC. a decrease of $100 million. nop- Tackle the Test: Free-Response Questions 1. Assume the MPC in an economy is 0.8 and the government increases government purchases of goods and services by $60 million. Also assume the absence of taxes, interna tional trade, and changes in the aggregate price level. a. What is the value of the spending multiplier? b. By how much will real GDP change as a result ofthe increase in government purchases? . What would happen to the size of the effect on real GDP if the MPC fell? Explain. . If we relax the assumption of no taxes, automatic Changes in tax revenue as income changes will have what effect on the size of the spending multiplier? . Suppose the government collects $60 million in taxes to balance its $60 million in expenditures. By how much would real GDP change as a result of this increase in both government spending and taxes? 216 Section 4 Notional Income and Price Determination 2. A change in government purchases of goods and ser- vices results in a change in real GDP equal to $200 mil lion. Assume the absence of taxes, international trade, and changes in the aggregate price level. a. Suppose that the MPC is equal to 0.75. What was the size of the change in government purchases of goods and services that resulted in the increase in real GDP of $200 million? 3. The presence of income taxes has what effect on the spending multiplier? They increase it. . decrease it. . destabilize it. negate it. . have no effect on it. up 09.0 lumpsum tax is higher as income increases. lower as income increases. independent of income. the most common form of tax. a type of business tax. 999FP> . Which of the following is NOT an automatic stabilizer? income taxes unemployment insurance Medicaid food stamps monetary policy 9999'.\" Rubric for FRQ 1 (6 points) 1 point: Spending multiplier = 1/(1 - MPC) = 1/(1 - 0.8) = 1/02 = s 1 point: $60 million X 5 = $300 million 1 point: It would decrease. 1 point: The spending multiplier is 1/ (1 - MPC). A fall in MPC increases the denominator, (1 - MPC), and therefore decreases the spending multiplier. 1 point: Decrease it 1 point: $60 million x 1 = $60 million b. Now suppose that the change in government pur- chases of goods and services was $20 million. What value of the spending multiplier would result in an increase in real GDP of $200 million? . Given the value of the spending multiplier you calcu- lated in part b, what marginal propensity to save would have led to that value of the spending multiplier? (3 points)