Problem Set 9 on Principles of Macroeconomics | ECO 101 | Assignments Introduction to Macroeconomics

Problem Set 9

Econ 101

1. Answer the following questions given the table below and an MPC=.75 and taxes are zero. Make sure you explain

how you found your answers and show any formulas you use.

Y C S

0 50

500

1000

1500

2000

a. Fill in the table above.

b. What is your MPS?

c. What are the consumption and saving functions?

d. Graph the consumption and saving functions. Label carefully.

2. Sketch a diagram with a 45-degree line and an aggregate expenditure line that describes macroeconomic spending

balance. What factors determine how steep the aggregate expenditure line is? What macroeconomic relationship does

the 45-degree line describe? Show on the diagram what will happen to the level of income if there is a rise in

government purchases. Does U.S. income increase by more or by less than the upward shift in government purchases?

Explain.

3. Given the following consumption function stated in algebraic form, calculate real GDP (Y) that results in spending

balance in the economy:

C=100+.5(Y-T)

I=200

G=200

X=100

T=200

a. Suppose you find out that government purchases will increase to 300 next year. What is your forecast of real GDP for

next year? Which way did the AE line shift?

b. Suppose businesses are pessimistic about how the economy will do next year. They decide to decrease their spending

on plant and equipment by 100. How will this shift the AE line and by how much? What is the new level of real

GDP?

c. Now suppose that the marginal propensity to consume is .6 instead of .5. How does this affect the level of real GDP at

spending balance? Why?

d. Explain what happens when the government decides to increase taxes by $50 per person. Which way does the AE line

shift? Why? How does this affect real GDP in the economy?

e. Suppose the government decides to increase taxes and government purchases by the same amount, that is T and G both

rise to 300. Calculate the new equilibrium Y and compare it to the original equilibrium with G=T=200. Why did Y go

up when both T and G rose by the same amount?

4. Suppose government purchases will increase by $100 billion, and a forecasting firm predicts that real GDP will rise in

the short run by $100 billion as a result. Would you say that forecast is accurate? Why? If you were running a

business and subscribe to that forecasting service, what questions would you ask about the forecast?

5. Suppose that American goods suddenly become unpopular in Europe. What happens to net exports? How will this

shift the AE line? What happens to real GDP? Demonstrate this in a diagram.

6. Let the consumption function be given by C=1+.6(Y-T) where T = taxes. Suppose I+G+X = 3. Everything is

measured in trillions of dollars.

a. Find real GDP (Y) when T=1.

b. Now increase T to 1.2. What happens to Y compared to part a.?

c. Now decrease T to .8. What happens to Y compared to part a.?

d. Using these results, explain how changes in taxes would affect one’s short-term forecast of real GDP.

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Problem Set 9 Econ 101

1. Answer the following questions given the table below and an MPC=.75 and taxes are zero. Make sure you explain how you found your answers and show any formulas you use. Y C S 0 50 500 1000 1500 2000 a. Fill in the table above. b. What is your MPS? c. What are the consumption and saving functions? d. Graph the consumption and saving functions. Label carefully. 2. Sketch a diagram with a 45-degree line and an aggregate expenditure line that describes macroeconomic spending balance. What factors determine how steep the aggregate expenditure line is? What macroeconomic relationship does the 45-degree line describe? Show on the diagram what will happen to the level of income if there is a rise in government purchases. Does U.S. income increase by more or by less than the upward shift in government purchases? Explain. 3. Given the following consumption function stated in algebraic form, calculate real GDP (Y) that results in spending balance in the economy: C=100+.5(Y-T) I= G= X= T= a. Suppose you find out that government purchases will increase to 300 next year. What is your forecast of real GDP for next year? Which way did the AE line shift? b. Suppose businesses are pessimistic about how the economy will do next year. They decide to decrease their spending on plant and equipment by 100. How will this shift the AE line and by how much? What is the new level of real GDP? c. Now suppose that the marginal propensity to consume is .6 instead of .5. How does this affect the level of real GDP at spending balance? Why? d. Explain what happens when the government decides to increase taxes by $50 per person. Which way does the AE line shift? Why? How does this affect real GDP in the economy? e. Suppose the government decides to increase taxes and government purchases by the same amount, that is T and G both rise to 300. Calculate the new equilibrium Y and compare it to the original equilibrium with G=T=200. Why did Y go up when both T and G rose by the same amount? 4. Suppose government purchases will increase by $100 billion, and a forecasting firm predicts that real GDP will rise in the short run by $100 billion as a result. Would you say that forecast is accurate? Why? If you were running a business and subscribe to that forecasting service, what questions would you ask about the forecast? 5. Suppose that American goods suddenly become unpopular in Europe. What happens to net exports? How will this shift the AE line? What happens to real GDP? Demonstrate this in a diagram. 6. Let the consumption function be given by C=1+.6(Y-T) where T = taxes. Suppose I+G+X = 3. Everything is measured in trillions of dollars. a. Find real GDP (Y) when T=1. b. Now increase T to 1.2. What happens to Y compared to part a.? c. Now decrease T to .8. What happens to Y compared to part a.? d. Using these results, explain how changes in taxes would affect one’s short-term forecast of real GDP.

Multiple Choice practice problems (not for quiz):

Economic fluctuations occur primarily because of changes in a. potential GDP. b. inflation. c. aggregate supply. d. aggregate demand. e. nominal GDP.
In a boom year a. potential GDP is greater than real GDP. b. potential GDP is less than real GDP. c. real GDP is less than potential GDP. d. potential GDP equals real GDP.
If capacity utilization is 70 percent, a. the unemployment rate will be above the natural unemployment rate. b. workers will be called back from previous layoffs. c. the unemployment rate will equal the natural unemployment rate. d. the unemployment rate will be below the natural rate of unemployment.
A firm's uncertainty about reasons for changes in demand is due to a. limited information. b. nominal rigidities. c. implicit contracts. d. economic fluctuations. e. irrational expectations.
The implicit contract and limited information approach is used to explain a. why prices respond quickly to changes in demand. b. why changes in demand initially lead to a reduction in prices. c. why changes in demand initially lead to a change in output. d. why changes in demand initially lead to an increase in prices. e. why output does not respond to changes in demand.
One year-ahead-forecasts for real GDP a. are usually equal to the current year's GDP. b. are usually equal to a weighted average of real GDP over the past five years. c. reflect forecasters' beliefs about the determinants of potential GDP over the next year. d. have no real use and are seldom done. e. reflect what forecasters believe will happen to the different spending components of real GDP.
Which of the following statements is true? a. A change in government purchases has no effect on the other spending components of real GDP. b. Assuming everything else held equal, an increase in net exports of $100 billion will cause real GDP to increase by $100 billion. c. A change in investment expenditures has no effect on the other spending components of real GDP. d. Accounting for how changes in one spending component affect another would improve a forecast.

The consumption function shows the relationship between consumption and a. income. b. the interest rate. c. the price level. d. potential GDP. e. the money supply.
According to the consumption function shown in Fig. 4, the marginal propensity to consume equals a. 0.6. b. 1.0. c. 0.9. d. 0.75.
If the marginal propensity to consume declines, then a. for any given change in income, there will be a smaller change in consumption. b. for any given change in consumption, there will be a smaller change in income. c. for any given change in income, there will be a larger change in consumption. d. nothing will happen to the consumption function. e. for any given change in income, there will be a smaller change in saving.
Disposable income is equal to a. real per capita GDP. b. real GDP. c. the income of households less the amount they pay in taxes. d. nominal GDP. e. consumption per capita.
The consumption relationship in this chapter assumes that interest and wealth do not affect consumption a. because the interest rate effect cancels out the wealth effect. b. because interest rates and wealth have little effect on consumption. c. in order to keep the analysis manageable at this stage. d. because economists do not understand how interest rates and wealth affect consumption.

Which of the following statements is true? a. A change in government purchases affects income. However, this change in income does not affect consumption. b. A change in government purchases affects GDP but not income. c. A change in government purchases has no effect on GDP but it does affect consumption. d. A change in government purchases affects GDP which is the same as income. The change in income affects consumption. e. A change in government purchases does not affect income or consumption.
If foreigners decide to increase their purchases of U.S.-produced consumer goods, then a. real GDP will increase by the same amount that net export spending increased. b. real GDP will decrease by the same amount that net export spending decreased. c. the increase in net exports will cause U.S. income to increase, which will cause consumption to increase. d. the increase in net exports will cause U.S. income to fall, which will cause consumption to decrease. e. the increase in net exports will have no effect on U.S. income or consumption.
Along the 45-degree line a. spending equals income. b. spending is equal to the marginal propensity to consume times income. c. real GDP equals nominal GDP. d. Not enough information is given. e. spending is greater than income.
If imports increase by $10 billion and exports increase by $10 billion, then a. the aggregate expenditure line will not shift. b. the aggregate expenditure line will shift up by less than $10 billion. c. the aggregate expenditure line will shift up by $10 billion. d. the aggregate expenditure line will shift down by $10 billion.
The slope of the aggregate expenditure line is a. greater than the slope of the 45-degree line. b. less than the slope of the 45-degree line. c. equal to the slope of the 45-degree line. d. equal to zero. e. equal to 1.
An increase in the marginal propensity to consume results in a. the aggregate expenditure line getting steeper. b. the aggregate expenditure line shifting up in a parallel direction. c. the aggregate expenditure line getting flatter. d. the aggregate expenditure line shifting down in a parallel direction. e. no change in the aggregate expenditure line.
An increase in investment results in a. the intercept of the AE line getting larger. b. the intercept of the AE line decreasing. c. the slope of the AE line getting larger. d. the slope of the AE line decreasing. e. both the intercept and the slope of the AE line increasing.

c. The AE line would shift up by $10 billion. d. The AE line would shift down by $20 billion. e. The AE line would shift up by $7 billion.

Problem Set 9 on Principles of Macroeconomics | ECO 101, Assignments of Introduction to Macroeconomics

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