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that each $60 of additional income leads to $40 more in

1.

consumer spending, so the MPC is 40/60 5 2/3, and the

multiplier is 1/[1 2 (2/3)] 5 3. So a shift in consumption

of 40 should raise equilibrium GDP by 120, which it does.

GDP Exports Imports Net Exports

2,500 400 250 150

Answers to Appendix A Questions

3,000 400 300 100

1. Y 5 C 1 I 1 G 1 (X 2 IM) 3,500 400 350 50

4,000 400 400 0

C 5 150 1 0.75(Y 2 400)

4,500 400 450 вЂ“50

C 5 150 1 0.75Y 2 300

5,000 400 500 вЂ“100

C 5 2150 1 0.75Y

Y 5 2150 1 0.75Y 1 300 1 400 2 50

Y 5 0.75Y 1 500

F I GU R E 4

0.25Y 5 500

Y 5 4 3 500 5 2,000

5,000

3. Saving is equal to disposable income minus consumption.

In Question 1: S 5 (Y 2 T) 2 C C + I + G1 + (X1 вЂ“ IM)

4,500

S 5 (2,000 2 400) 2 [2150 1 0.75(2000)]

S 5 1,600 2 (2150 1 1,500) 4,000

Spending

C + I + G + (X0 вЂ“ IM)

S 5 1,600 2 1,350

3,500

S 5 250

S is not equal to I. (In Question 2, S is equal to I. The dif- 3,000

ference is that X and IM are equal in Question 2 but

unequal in Question 1. 2,500

5. (a) Y 5 C 1 I 1 G 1 (X 2 IM) 45В°

C 5 100 1 0.8(Y 2 500)

0

0

0

0

0

0

50

00

50

00

50

00

C 5 100 1 0.8Y 2 400

2,

3,

3,

4,

4,

5,

C 5 2300 1 0.8Y Income

Y 5 2300 1 0.8Y 1 700 1 500 1 0

Y 5 0.8Y 1 900 3. In Figure 4, the intersection of the upper expenditure

0.2Y 5 900 line with the 45В° line shows an equilibrium GDP of

4,500. (The lower expenditure line shows the solution to

Y 5 5 3 900 5 4,500

Test Yourself Question 2, with a GDP of 4,000.) Exports

have risen by 250, and GDP has risen by 500, so the

multiplier is 2.

Copyright 2009 Cengage Learning, Inc. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part.

Licensed to:

Appendix 399

(b) Initial equilibrium: P 5 100, Y 5 3,800. Eventual

CHAPTER 10: equilibrium: P 5 110, Y 5 3,940. The multiplier, taking

Supply-Side Equilibrium: account of price increases, is 140/20 5 7, which is less

Unemployment and Inflation? than 10.

1.

CHAPTER 11:

Managing Aggregate Demand: Fiscal

F I GU R E 1

Policy

Full employment 1.

Aggregate supply

110

GDP Taxes Disposable Income Consumption Total Expenditure

105

Price Level

1,360 400 960 720 1,450

100 1,480 400 1,080 810 1,540

1,600 400 1,200 900 1,630

95

1,720 400 1,320 990 1,720

Aggregate

1,840 400 1,440 1,080 1,810

demand

90

00 00 00 00 00

F I GU R E 1

8 9 0 1 2

2, 2, 3, 3, 3,

GDP

C + I + G0 + (X вЂ“ IM)

Equilibrium real output is $3,000, while the price level is

C + I + G1 + (X вЂ“ IM)

100. Since full employment is at $2,800 billion, there is an

Spending

inflationary gap of 200.

3.

F I GU R E 2

45В°

0

0

0

0

0

115

36

48

60

72

84

1,

1,

1,

1,

1,

110 Income

Price Level

105

Equilibrium GDP is 1,720 (see diagram). The marginal

propensity to consume is 0.75 and the multiplier is 4. If

100

government purchases fall by 60, and the price level is

unchanged, GDP would fall by 4 3 60 5 240, that is, to

95

1,480.

3. At each level of GDP, G is now higher by 120, while C is

90

lower by 3вЃ„4 of 120, or 90. Therefore, there is a net increase

in total expenditure of 30 at each level of GDP, as shown

3,600 3,700 3,800 3,900 4,000 4,100

in the following table:

GDP

GDP Taxes Disposable Income Consumption Total Expenditure

(a) In Chapter 9, Test Yourself Question 2, the marginal

1,360 520 840 630 1,480

propensity to consume was 0.9, and the (oversimpli-

1,480 520 960 720 1,570

fied) multiplier was therefore 10. The table in this

1,600 520 1,080 810 1,660

question confirms that when investment rises by 20,

from 240 to 260, aggregate demand rises by 200 at 1,720 520 1,200 900 1,750

any given price level. For example, at a price level of 1,840 520 1,320 990 1,840

105, aggregate demand rises from 3,770 to 3,970.

Copyright 2009 Cengage Learning, Inc. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part.

Licensed to:

Appendix

400

Equilibrium GDP is now 1,840, which is 120 more than in spending in the first round by the marginal propen-

Test Yourself Question 1. sity to consume times the tax reduction. So the tax

multiplier is the multiplier found above, multiplied

5. The answer to Test Yourself Question 2 is 1,720. So you

by (minus) the MPC, or 2.5 3 (20.8) 5 22.

want to increase GDP by 120 (raising it to 1,840). Because

2. Raise fixed taxes in the model from 200 to 201.

the marginal propensity to consume is 0.75, and the mar-

Working through the algebra, this comes to

ginal tax rate is 1вЃ„3, the multiplier is 2. Therefore, you must

0.4Y 5 679.2, or Y 5 1,698. So an increase in taxes of

take some action that will have the initial effect of raising

1 has reduced GDP by 2, and the multiplier is 22.

expenditure by 60. You may raise government spending

on GDP by 60, or you may lower taxes or raise transfer 3. From the formula in the appendix, the tax multiplier is

payments by 80 (since 3вЃ„4 of 80 is 60).

2b/1 2 b(1 2 t) 5 20.8/[1 2 0.8(1 2 0.25)] 5 20.8/[1

2 0.8(0.75)] 5 20.8/(1 2 0.6) 5 20.8/0.4 = 22

Answers to Appendix A Questions To raise GDP by 100, the government can (a) raise G by

40, and the multiplier of 2.5 will do the rest, or (b) lower

1. (a) variable tax (as GDP rises, people drive more); taxes or raise transfer payments by 50, and the multiplier

(b) variable tax; (c) fixed tax; (d) variable tax of вЂ“2 will do the rest.

3. The higher fixed tax reduces consumer spending, but 3. (a) Y 5 C 1 I 1 G 1 (X 2 IM)

the lower income-tax rate increases consumer spending.

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