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two income levels. The numbers in the table above show
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.

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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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