Chapter 19: Problem 11

In Exhibit \(9,\) the spending multiplier for this economy is equal to a. \(1^{2 / 3}\). b. \(2^{1 / 2}\). c. 3. d. 5.

Short Answer

Expert verified

In conclusion, without any further information like Exhibit 9 mentioned in the exercise, it's impossible to definitively decide which of these options, 1, \(\sqrt{2}\), 3, or 5, is the correct spending multiplier for this economy. However, these four options represent distinct cases of the spending multiplier.

Step by step solution

Understanding the spending multiplier

The spending multiplier (also known as the fiscal multiplier) is a concept in economics that describes how an initial change in autonomous spending leads to a more substantial change in real GDP. It measures the effect of a change in spending on the overall output or real GDP of an economy.

Evaluating the options

In this exercise, we are given four possible values for the spending multiplier: a. \(1^{2 / 3}\) b. \(2^{1 / 2}\) c. 3 d. 5 Let's evaluate or simplify these options: - For option (a), \(1^{2 / 3} = 1\), - For option (b), \(2^{1 / 2} = \sqrt{2}\), - The other two options c and d are already given as simple numbers. So, the four options can be rewritten as 1, \(\sqrt{2}\), 3, and 5.

Interpreting the options

Now that we have the values for each option: - A spending multiplier of 1 implies that a change in initial spending does not lead to any change in the real GDP - essentially, there is no multiplier effect. - A spending multiplier of \(\sqrt{2}\) (about 1.41) means an initial change in spending leads to an approximately 1.41 times larger change in the real GDP. - A spending multiplier of 3 means that each dollar of initial spending results in a three-dollar increase in GDP. - A spending multiplier of 5 suggests even greater growth: each dollar of initial spending results in five dollars in GDP.

Conclusion

In conclusion, without any further information like the Exhibit \(9\) mentioned in the exercise, it's impossible to definitively decide which of these options is the correct spending multiplier for this economy. However, these four options represent distinct cases of the spending multiplier.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Fiscal Multiplier

The fiscal multiplier, also often termed as the spending multiplier, is a crucial element in Keynesian economic theories. It provides insight into the impact of government spending or any autonomous changes in spending on the nation's economic activity. Simply put, the multiplier tells us how much the real Gross Domestic Product (GDP) will increase following an injection of spending.

This concept is grounded in the idea that one person's spending becomes another person's income, who then spends it further, creating a cascading effect throughout the economy. The magnitude of the multiplier depends on various factors, such as the marginal propensity to consume (MPC) or the level of unused economic capacity. Generally, the multiplier is larger when the MPC is higher, meaning that people spend a larger portion of additional income.

Autonomous Spending

Autonomous spending refers to expenditures that do not depend on the current level of national income or output. This type of spending is considered 'autonomous' because it is assumed to be independent of economic fluctuations - it will occur no matter what the economic conditions are.

Examples include government spending on infrastructure or social programs, consumer's minimum expenditure on necessities, and businesses investing in projects with long-term horizons. Autonomous spending is significant because it can kickstart economic activity during a slowdown. By injecting funds into the economy, autonomous spending can trigger the multiplier effect, influencing the level of overall economic output.

Real GDP

Real GDP, or Gross Domestic Product adjusted for inflation, is the total economic output of a country valued at constant prices. This measure strips out the effects of price level changes over time, which means it reflects the true volume of goods and services produced.

As a key indicator of economic health, real GDP helps us understand a country's economic performance and standard of living. An increase in real GDP signifies economic growth, suggesting improvements in productivity, better use of resources, and potentially higher levels of employment. It's critical to differentiate real GDP from nominal GDP, which is the raw measurement of all goods and services without adjusting for inflation.

Economic Output

Economic output quantifies the total value of goods and services produced by an economy over a specific period. It is the bread and butter of economic analysis, often synonymous with terms like 'economic activity' or 'economic performance.'

Policymakers, economists, and investors closely watch economic output to gauge an economy's strength and to make informed decisions. When output increases, it typically means more jobs, higher income, and improved living standards. Conversely, a decline in output can signal recessionary pressures, with adverse economic and social impacts. Understanding the relationship between autonomous spending, fiscal policy, and how these affect economic output is critical for effective macroeconomic management.