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Solution

The following table illustrates the completed table. The equilibrium is level is italicized.

National Income After-tax Income Consumption I + G + X Minus Imports Aggregate Expenditures
$8,000 $4,800 $4,340 $5,000 $240 $9,100
$9,000 $5,400 $4,820 $5,000 $270 $9,550
$10,000 $6,000 $5,300 $5,000 $300 $10,000
$11,000 $6,600 $5,780 $5,000 $330 $10,450
$12,000 $7,200 $6,260 $5,000 $360 $10,900
$13,000 $7,800 $46,740 $5,000 $4,390 $11,350

The alternative way of determining equilibrium is to solve for Y, where Y = national income, using: Y = AE = C + I + G + X – M

Y = $500 + 0.8(Y – T) + $2,000 + $1,000 + $2,000 – 0.05(Y – T)

Solving for Y, we see that the equilibrium level of output is Y = $10,000.

Explain how the multiplier works. Use an MPC of 80% in an example.

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Solution

The multiplier refers to how many times a dollar will turnover in the economy. It is based on the Marginal Propensity to Consume (MPC) which tells how much of every dollar received will be spent. If the MPC is 80% then this means that out of every one dollar received by a consumer, $0.80 will be spent. This $0.80 is received by another person. In turn, 80% of the $0.80 received, or $0.64, will be spent, and so on. The impact of the multiplier is diluted when the effect of taxes and expenditure on imports is considered. To derive the multiplier, take the 1/1 – F; where F is equal to percent of savings, taxes, and expenditures on imports.

Review questions

What is on the axes of an expenditure-output diagram?

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What does the 45-degree line show?

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What determines the slope of a consumption function?

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What is the marginal propensity to consume, and how is it related to the marginal propensity to import?

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Why are the investment function, the government spending function, and the export function all drawn as flat lines?

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Why does the import function slope down? What is the marginal propensity to import?

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What are the components on which the aggregate expenditure function is based?

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Is the equilibrium in a Keynesian cross diagram usually expected to be at or near potential GDP?

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What is an inflationary gap? A recessionary gap?

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What is the multiplier effect?

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Why are savings, taxes, and imports referred to as “leakages” in calculating the multiplier effect?

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Will an economy with a high multiplier be more stable or less stable than an economy with a low multiplier in response to changes in the economy or in government policy?

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How do economists use the multiplier?

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Critical thinking questions

What does it mean when the aggregate expenditure line crosses the 45-degree line? In other words, how would you explain the intersection in words?

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Which model, the AD/AS or the AE model better explains the relationship between rising price levels and GDP? Why?

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What are some reasons that the economy might be in a recession, and what is the appropriate government action to alleviate the recession?

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What should the government do to relieve inflationary pressures if the aggregate expenditure is greater than potential GDP?

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Two countries are in a recession. Country A has an MPC of 0.8 and Country B has an MPC of 0.6. In which country will government spending have the greatest impact?

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Compare two policies: a tax cut on income or an increase in government spending on roads and bridges. What are both the short-term and long-term impacts of such policies on the economy?

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What role does government play in stabilizing the economy and what are the tradeoffs that must be considered?

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If there is a recessionary gap of $100 billion, should the government increase spending by $100 billion to close the gap? Why? Why not?

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What other changes in the economy can be evaluated by using the multiplier?

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References

Joyner, James. Outside the Beltway. “Public Financing of Private Sports Stadiums.” Last modified May 23, 2012. http://www.outsidethebeltway.com/public-financing-of-private-sports-stadiums/.

Siegfried, John J., and Andrew Zimbalist. “The Economics of Sports Facilities and Their Communities.” Journal of Economic Perspectives . no. 3 (2000): 95-114. http://pubs.aeaweb.org/doi/pdfplus/10.1257/jep.14.3.95.

Questions & Answers

list three possible ways of addressing and adverse balance of payment
Meribah Reply
when MPs is 0.3 and autonomous consumption is 30billion what is d consumption expenditure
queen Reply
what is macroeconomic?
Shahidul
Consumption expenditure becomes: C = 30b + 0.3Y without lump sum tax and C = 30b + 0.3Yd with lump sum tax
olumide
Macroeconomics deals with the study of the behavior of aggregate individuals, firms or government in an economy in relation to consumption patterns and decision making
olumide
If the government decrases spending by ksh. 500 billion what is the change in output given MPC is 0.75
Gichana Reply
375
Philip
how can policy makers strike the balance between inflation and unemployment?
Oreva Reply
c=800 + 0.75y i=500 G=900 compute the equilibrium level of national output
Omar Reply
y=c+I+g+(X-M) y=800+.75y+500+900+0 y-.75y=2200 .25y=2200 y=2200/.25 y=8800=national level of output
Anik
Please tell me the current crr, repo rate etc
Ranjeeta Reply
cash reserve ratio is the amount that is deposit by the commercial bank in Central bank.... n repo rate is a loan interest amount
Sahar
what is slr madam sahar
Rohit
jo amount bank reserve rakhti hai bank mai customers k liye jese ATM mai ya bank mai rakha hota hai, wo slr hota hai
Sahar
pakka sahi hai
Rohit
good joke
Rohit
Argentina Lose !!😭😭
MR.ASHIM
SLR refers to that portion of total deposits of a commercial bank which it has to keep with itself in the form of cash reserve
Ranjeeta
What is cash crop?
Ranjeeta Reply
commeciaal crops
Amal
So jowar is not cash crop?
Ranjeeta
anything which is plant inorder to sell in the market
Simeon
How demand deposits are different from savings?
Ranjeeta
can unemployment be a factor of inflation?
David Reply
yeah it has an impact on cost push inflation
Vincent
microeconomics is individual firms and macroeconomics is a large as a full
kendra Reply
That's true 👍
Kwibuka
word micro means small and tiny part. word macro means large and big part.
saddiq
Exactly
Emmanuel
is unemployment another cause of inflation?
David
can I say unemployment can cause inflation?
David
no. unemployment can possibly lead to deflation
Asdfghjkl
if their are no production am I correct to say inflation will occurs
David
one of the causes of inflation is excess demand. if there's no production there would be no demand so no inflation
Asdfghjkl
if we take a look at inflation, it occur because of low production. High price chasing few goods.
David
So are you saying demand creates supply?
David
to an extent because if s9mething is demanded, it's likely to be supplied
Asdfghjkl
OK am still confused, if there is unemployment low production, and employment high production, inflation high increase in price, how can production be high and we are faced with inflation? When inflation is referred to higher price chasing few goods.
David
if the demand is increased , what is the graphics on it?
Tadesse Reply
what is macroeconomics
Prosenjit Reply
large-scale economics, such as interest rates or the gross national national product rate of of a country
Michael
Macroeconomics: is a branch of economics dealing with the performance, structure, behavior, and decision-making of an economy as a whole. This includes regional, national, and global economies.
Khadar
well said
Michael
hello everyone, would like to ask a favor... i need your help to answer this problem: Assume that equilibrium GDP is 400B; potential GDP is 500B, the marginal propensity to consume is 9/10, the interest rate is 8%, investment spending is P20B, the money supply is 120B, and the reserve requirement
Jerelyn
is 1/10. By how much and in what direction should the Fed change the monetary base?
Jerelyn
what are the factors that influence surplus budget? and its effects
Christopher Reply
what is credit creation
Christopher
join
Christopher
how monetary and fiscal policy affect money supply? on economy
Christopher Reply
what is hyperinflation
David Reply
what is stagflation
Riaz
in an economy when there is both inflation & unemployment prevailing at the same time.
Yogesh
@david - hyperinflation is very rapid inflation; it is sometimes reckoned to set in when price increases exceed 50 percent per month. Such rapid inflation not merely makes money useless as a store of value, but seriously affects its use as a medium of exchange
sagar
thanks
Riaz
@yogesh: the one you are describing is Stagflation
Tutohar
I was answering to Riaz's querry.
Yogesh
Sorry, didn't see the question
Tutohar
what is credit creation?
Christopher
what are the factors that influencing surplus budget
Christopher
may I ask master level questions on this chat?
saddiq Reply
yes
deepali
am so confused about the concept of scarcity. can u hlp me
saddiq
 · Concepts of Scarcity. Scarcity refers to the condition of insufficiency where the human beings are incapable to fulfill their wants in sufficient manner. In other words, it is a situation of fewer resources in comparison to unlimited human wants. Human wants are unlimited.
Shittu
what is PPC
Kalpana
Production possibility curve is a curve that shows different possibilities of production of a set of two good which can be produced with the given resources
Ranjeeta
micro vs macro which is complex in your view?
Bijaya

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Source:  OpenStax, Macroeconomics. OpenStax CNX. Jun 16, 2014 Download for free at http://legacy.cnx.org/content/col11626/1.10
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