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Chapter 21: Q 8. (page 566)

If firms suddenly become more optimistic about the profitability of investment and planned investment spending rises by \(100 billion, while consumers become

more pessimistic and autonomous consumer spending falls by \)100 billion, what happens to aggregate output?

Short Answer

Expert verified

There is no change in Aggregate output.

Step by step solution

01

Step 1. Introduction

Aggregate output is determined at equilibrium level, where Aggregate Demand = Aggregate Supply.

Aggregate Demand comprises of planned expenditure by sectors of a closed economy : consumption expenditure by households, investment expenditure by firms, government spendings by government.

AD = C + I + G

02

Explanation 

If firms' planned investment expenditure increase, & households' planned consumption expenditure reduces : Simultaneous increase & decrease in components of Aggregate demand nullify each other, imply that AD remains constant.

So, the equilibrium level of income & output also remains same.

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Most popular questions from this chapter

Go to http://www.eurmacro.unisg.ch/Tutor/islm.html. Set the policy instruments to G = 80, t = 0.20, c = 0.75, and b = 40. Now increase the sensitivity of investment

to the interest rate, b, from 40 to 80. What happens to the slope of the IS curve? Why

Assuming both taxes and government spending increase by the same amount, derive an expression for the effect on equilibrium output.

In each of the following cases, determine whether the IS curve shifts to the right or left, does not shift, or is indeterminate in the direction of shift.

a. The real interest rate rises.

b. The marginal propensity to consume declines.

c. Financial frictions increase.

d. Autonomous consumption decreases.

e. Both taxes and government spending decrease by the same amount.

f. The sensitivity of net exports to changes in the real interest rate decreases.

g. The government provides tax incentives for research and development programs for firms.

Calculate the value of the consumption function at each level of income in the following table if autonomous consumption = 300, taxes = 200, and mpc = 0.9.

Consider an economy described by the following data:

C=\(4trillionI=\)1.5trillionG=\(3.0trillionT=\)3.0trillionNX=\(1.0trillionf=0

mpc = 0.8

d = 0.35

x = 0.15

a. Derive an expression for the IS curve.

b. Assume that the Federal Reserve controls the interest rate and sets the interest rate at r = 4. What is the equilibrium level of output?

c. Suppose that a financial crisis begins and f increases to f = 3. What will happen to equilibrium output? If the Federal Reserve can set the interest rate, then at what level should the interest rate be set to keep output from changing?

d. Suppose the financial crisis causes f to increase as indicated in part (c) and also causes planned autonomous investment to decrease to I = \)1.1 trillion. Will the change in the interest rate implemented by the Federal Reserve in part (c) be effective in stabilizing output? If not, what additional monetary or fiscal policy changes could be implemented to stabilize output at the original equilibrium output level given in part (b)?
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