Log out Go to App
Go to App

Learning Materials

Features

Discover

Chapter 23: Problem 8

An article published in an economics journal found the following: "For the poorest households, the marginal propensity to consume was close to \(70 \% .\) For the richest households, the MPC was only \(35 \%\)." Assume that the macroeconomy can be divided into three sections. Section A consists of the poorest households, Section \(\mathrm{B}\) consists of the richest households, and Section C consists of all other households. a. Compute the value of the multiplier for Section A. b. Compute the value of the multiplier for Section \(\mathrm{B}\). c. Assume that there was an increase in planned investment of \(\$ 4\) billion. Compute the change in equilibrium real GDP if the \(M P C\) for the economy was 70 percent (or 0.70\()\). Compute the change in equilibrium real GDP if the \(M P C\) for the economy was 35 percent (or 0.35\()\).

Short Answer

Expert verified
a. The multiplier for Section A (poorest households) is \(1 / (1 - 0.7) = 3.33\) \n b. The multiplier for Section B (richest households) is \(1 / (1 - 0.35) = 1.54\) \n c. The increase in equilibrium real GDP for a MPC of 70% is \(3.33 * 4 = \$13.32\) billion. For a MPC of 35%, the increase in equilibrium real GDP is \(1.54 * 4 = \$6.16\) billion.

Step by step solution

01

Calculate the Multiplier for Section A and Section B

The multiplier is calculated using the formula \( 1 / (1 - MPC) \). Since the MPC for the poorest households is given as \(70\% = 0.7\) for Section A, and \(35\% = 0.35\) for Section B, we use these values in our formula to calculate the multipliers for Sections A and B respectively.
02

Compute the change in equilibrium GDP

Based on the given increase in planned investment of $4 billion, we can compute the changes in the equilibrium GDP for different MPC values. The change in GDP is calculated as \( Change\_in\_GDP = multiplier * change\_in\_investment\). We use the calculated multipliers from Step 1, and the change in investment of $4 billion, to calculate the new equilibrium GDP for the economy if the MPC was 70 percent (or 0.7), and if it was 35 percent (or 0.35).
03

Interpretation of Results

The computed results will show how changes in the MPC affect the multipliers and subsequently, the real GDP in an economy. A higher multiplier represents greater sensitivity to changes in investment, resulting in larger changes in GDP.

Unlock Step-by-Step Solutions & Ace Your Exams!

  • Full Textbook Solutions

    Get detailed explanations and key concepts

  • Unlimited Al creation

    Al flashcards, explanations, exams and more...

  • Ads-free access

    To over 500 millions flashcards

  • Money-back guarantee

    We refund you if you fail your exam.

Start your free trial

Over 30 million students worldwide already upgrade their learning with Vaia!

One App. One Place for Learning.

All the tools & learning materials you need for study success - in one app.

Get started for free

Most popular questions from this chapter

An article on bloomberg.com about the Japanese economy noted, "Whether the 2.4 percent annualized gain in gross domestic product reported Wednesday can be maintained depends on consumers stepping in to buy the products that companies are piling up in warehouses." a. Did business inventories in Japan increase or decrease during this period? Briefly explain. b. What would happen if consumers do not buy the products that companies are piling up? Illustrate your answer with a \(45^{\circ}\) -line diagram.

What is the meaning of the \(45^{\circ}\) line in the \(45^{\circ}\) -line diagram?

Unemployed workers receive unemployment insurance payments from the government. Does the existence of unemployment insurance make it likely that consumption will fluctuate more or less over the business cycle than it would in the absence of unemployment insurance? Briefly explain.

According to an article in the Wall Street Journal, in late 2014, the Japanese economy experienced a large increase in business inventories. The article noted, "The large buildup of inventories is a reflection that the \(\ldots\) drop in demand was bigger than expected." Does it matter that Japanese firms didn't expect the drop in demand? Won't a decline in demand always lead to an increase in firms' holdings of inventories? Briefly explain.

An economics student raises the following objection: "The chapter said that a higher interest rate lowers investment, but this doesn't make sense. I know that if I can get a higher interest rate, I am certainly going to invest more in my savings account." Briefly explain whether you agree with this reasoning.
See all solutions

What do you think about this solution?

We value your feedback to improve our textbook solutions.

Study anywhere. Anytime. Across all devices.

Sign-up for free