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Chapter 26: Problem 2

Assuming that the aggregate price level is constant, the interest rate is fixed, and there are no taxes and no foreign trade, what will be the change in GDP if the following events occur? a. There is an autonomous increase in consumer spending of \(\$ 25\) billion; the marginal propensity to consume is \(2 / 3\). b. Firms reduce investment spending by \(\$ 40\) billion; the marginal propensity to consume is 0.8 . c. The government increases its purchases of military equipment by \(\$ 60\) billion; the marginal propensity to consume is 0.6

Short Answer

Expert verified
Answer: The changes in GDP for parts a, b, and c are: a. $75 billion, b. -$200 billion, and c. $150 billion.

Step by step solution

01

Find the spending multiplier

The spending multiplier (M) is calculated as \(M = \frac{1}{1 - MPC}\), where MPC is the marginal propensity to consume. In part a, the MPC is \(\frac{2}{3}\), so the multiplier is: \(M = \frac{1}{1 - \frac{2}{3}} = \frac{1}{\frac{1}{3}} = 3\)
02

Calculate the change in GDP

To find the change in GDP, we use the spending multiplier and the autonomous increase in consumer spending. In part a, the autonomous increase is \(\$ 25\) billion, so the change in GDP is: \(\Delta GDP_{a} = M \times Autonomous Increase = 3 \times \$ 25\) billion = \(\$ 75\) billion Part b:
03

Find the spending multiplier

In part b, the MPC is \(0.8\). So, the multiplier is: \(M = \frac{1}{1 - 0.8} = \frac{1}{0.2} = 5\)
04

Calculate the change in GDP

In part b, firms reduce investment spending by \(\$ 40\) billion. The change in GDP is: \(\Delta GDP_{b} = M \times Autonomous Decrease = 5 \times (- \$ 40\) billion) = - \$ 200$ billion Part c:
05

Find the spending multiplier

In part c, the MPC is \(0.6\). So, the multiplier is: \(M = \frac{1}{1 - 0.6} = \frac{1}{0.4} = 2.5\)
06

Calculate the change in GDP

In part c, the government increases its purchases of military equipment by \(\$ 60\) billion. The change in GDP is: \(\Delta GDP_{c} = M \times Autonomous Increase = 2.5 \times \$ 60\) billion = \(\$ 150\) billion In summary, the change in GDP for the three events a, b, and c are: a. \(\$ 75\) billion b. - \(\$ 200\) billion c. \(\$ 150\) billion

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Most popular questions from this chapter

Although the United States is one of the richest nations in the world, it is also the world's largest debtor nation. We often hear that the problem is the nation's low savings rate. Suppose policy makers attempt to rectify this by encouraging greater savings in the economy. What effect will their successful attempts have on real GDP?

Explain how each of the following actions will affect the level of planned investment spending and unplanned inventory investment. Assume the economy is initially in income-expenditure equilibrium. a. The Federal Reserve raises the interest rate. b. There is a rise in the expected growth rate of real GDP. c. A sizable inflow of foreign funds into the country lowers the interest rate.

The Bureau of Economic Analysis reported that, in real terms, overall consumer spending increased by \(\$ 66.2\) billion during the second quarter of \(2014 .\) a. If the marginal propensity to consume is \(0.52,\) by how much will real GDP change in response? b. If there are no other changes to autonomous spending other than the increase in consumer spending in part a, and unplanned inventory investment, \(I_{\text {Unplanned }}\), decreased by \(\$ 50\) billion, what is the change in real GDP? c. GDP at the end of the first quarter in 2014 was \(\$ 16,014.1\) billion. If GDP were to increase by the amount calculated in part b, what would be the percent increase in GDP?

The U.S. economy slowed significantly in early 2008 , and policy makers were extremely concerned about growth. To boost the economy, Congress passed several relief packages (the Economic Stimulus Act of 2008 and the American Recovery and Reinvestment Act of 2009) that combined would deliver about \(\$ 700\) billion in government spending. Assume, for the sake of argument, that this spending was in the form of payments made directly to consumers. The objective was to boost the economy by increasing the disposable income of American consumers. a. Calculate the initial change in aggregate consumer spending as a consequence of this policy measure if the marginal propensity to consume $(M P C)\( in the United States is \)0.5 .$ Then calculate the resulting change in real GDP arising from the \(\$ 700\) billion in payments. b. Illustrate the effect on real GDP with the use of a graph depicting the income-expenditure equilibrium. Label the vertical axis "Planned aggregate spending, \(A E_{\text {Planned }}\) " and the horizontal axis "Real GDP." Draw two planned aggregate expenditure curves $\left(A E_{\text {Planned } 1}\right.\( and \)A E_{\text {Planned } 2}$ ) and a 45 -degree line to show the effect of the autonomous policy change on the equilibrium.

How will planned investment spending change as the following events occur? a. The interest rate falls as a result of Federal Reserve policy. b. The U.S. Environmental Protection Agency decrees that corporations must upgrade or replace their machinery in order to reduce their emissions of sulfur dioxide. c. Baby boomers begin to retire in large numbers and reduce their savings, resulting in higher interest rates.
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