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Chapter 26: Problem 2

Assuming that the aggregate price level is constant, the interest rate is fixed, and there are no taxes and no foreign trade, what will be the change in GDP if the following events occur? a. There is an autonomous increase in consumer spending of \(\$ 25\) billion; the marginal propensity to consume is \(2 / 3\). b. Firms reduce investment spending by \(\$ 40\) billion; the marginal propensity to consume is 0.8 . c. The government increases its purchases of military equipment by \(\$ 60\) billion; the marginal propensity to consume is 0.6

Short Answer

Expert verified
Answer: The changes in GDP for parts a, b, and c are: a. $75 billion, b. -$200 billion, and c. $150 billion.

Step by step solution

01

Find the spending multiplier

The spending multiplier (M) is calculated as \(M = \frac{1}{1 - MPC}\), where MPC is the marginal propensity to consume. In part a, the MPC is \(\frac{2}{3}\), so the multiplier is: \(M = \frac{1}{1 - \frac{2}{3}} = \frac{1}{\frac{1}{3}} = 3\)
02

Calculate the change in GDP

To find the change in GDP, we use the spending multiplier and the autonomous increase in consumer spending. In part a, the autonomous increase is \(\$ 25\) billion, so the change in GDP is: \(\Delta GDP_{a} = M \times Autonomous Increase = 3 \times \$ 25\) billion = \(\$ 75\) billion Part b:
03

Find the spending multiplier

In part b, the MPC is \(0.8\). So, the multiplier is: \(M = \frac{1}{1 - 0.8} = \frac{1}{0.2} = 5\)
04

Calculate the change in GDP

In part b, firms reduce investment spending by \(\$ 40\) billion. The change in GDP is: \(\Delta GDP_{b} = M \times Autonomous Decrease = 5 \times (- \$ 40\) billion) = - \$ 200$ billion Part c:
05

Find the spending multiplier

In part c, the MPC is \(0.6\). So, the multiplier is: \(M = \frac{1}{1 - 0.6} = \frac{1}{0.4} = 2.5\)
06

Calculate the change in GDP

In part c, the government increases its purchases of military equipment by \(\$ 60\) billion. The change in GDP is: \(\Delta GDP_{c} = M \times Autonomous Increase = 2.5 \times \$ 60\) billion = \(\$ 150\) billion In summary, the change in GDP for the three events a, b, and c are: a. \(\$ 75\) billion b. - \(\$ 200\) billion c. \(\$ 150\) billion

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Most popular questions from this chapter

In an economy with no government and no foreign sectors, autonomous consumer spending is \(\$ 250\) billion, planned investment spending is \(\$ 350\) billion, and the marginal propensity to consume is \(2 / 3\). a. Plot the aggregate consumption function and planned aggregate spending. b. What is unplanned inventory investment when real GDP equals \(\$ 600\) billion? c. What is \(Y^{*}\), income-expenditure equilibrium GDP? d. What is the value of the multiplier? e. If planned investment spending rises to \(\$ 450\) billion, what will be the new \(Y^{*}\) ?

An economy has a marginal propensity to consume of \(0.5,\) and \(Y^{*},\) income- expenditure equilibrium GDP, equals \(\$ 500\) billion. Given an autonomous increase in planned investment of \(\$ 10\) billion, show the rounds of increased spending that take place by completing the accompanying table. The first and second rows are filled in for you. In the first row, the increase of planned investment spending of \(\$ 10\) billion raises real GDP and \(Y D\) by \(\$ 10\) billion, leading to an increase in consumer spending of \(\$ 5\) billion \((M P C \times\) change in disposable income) in row \(2,\) raising real GDP and \(Y D\) by a further \(\$ 5\) billion. a. What is the total change in real GDP after the 10 rounds? What is the value of the multiplier? What would you expect the total change in \(Y^{*}\) to be based on the multiplier formula? How do your answers to the first and third questions compare? b. Redo the table starting from round 2 , assuming the marginal propensity to consume is \(0.75 .\) What is the total change in real GDP after 10 rounds? What is the value of the multiplier? As the marginal propensity to consume increases, what happens to the value of the multiplier?

How will planned investment spending change as the following events occur? a. The interest rate falls as a result of Federal Reserve policy. b. The U.S. Environmental Protection Agency decrees that corporations must upgrade or replace their machinery in order to reduce their emissions of sulfur dioxide. c. Baby boomers begin to retire in large numbers and reduce their savings, resulting in higher interest rates.

The Bureau of Economic Analysis reported that, in real terms, overall consumer spending increased by \(\$ 66.2\) billion during the second quarter of \(2014 .\) a. If the marginal propensity to consume is \(0.52,\) by how much will real GDP change in response? b. If there are no other changes to autonomous spending other than the increase in consumer spending in part a, and unplanned inventory investment, \(I_{\text {Unplanned }}\), decreased by \(\$ 50\) billion, what is the change in real GDP? c. GDP at the end of the first quarter in 2014 was \(\$ 16,014.1\) billion. If GDP were to increase by the amount calculated in part b, what would be the percent increase in GDP?

Explain how each of the following actions will affect the level of planned investment spending and unplanned inventory investment. Assume the economy is initially in income-expenditure equilibrium. a. The Federal Reserve raises the interest rate. b. There is a rise in the expected growth rate of real GDP. c. A sizable inflow of foreign funds into the country lowers the interest rate.
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