Chapter 3: exerecises
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Name of Registrant : Charoensook, Banchongsan (101596)
Date : 09-20-2018 10:26:02
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Chapter 3: exerecises
CHAPTER 3
Quick Check
1. a. Y=160+0.6(Y-100)+150+150
Y=1000
b. YD=Y-T=1000-100=900
c. C=160+0.6(900)=700
2. a. True.
b. False. Government spending excluding transfers was 20.4% of GDP.
c. False. The propensity to consume must be less than one for our model to make sense.
d. True.
e. False.
f. False. The increase in equilibrium output is one times the multiplier.
g. False.
3. a. Equilibrium output is 1000. Total demand=C+I+G=700+150+150=1000. Total demand
equals production. We used this equilibrium condition to solve for output.
b. Output falls by (40 times the multiplier) = 40/(1-.6)=100. So, equilibrium output is now
900. Total demand=C+I+G=160+0.6(800)+150+110=900. Again, total demand equals
production.
c. Private saving=Y-C-T=900-160-0.6(800)-100=160. Public saving =T-G=-10. National
saving equals private plus public saving, or 150. National saving equals investment.
This statement is mathematically equivalent to the equilibrium condition, total demand
equals production. In other words, there is an alternative (and equivalent) equilibrium
condition: national saving equals investment.
Dig Deeper
4. a. Y=c0+c1YD+I+G implies
Y=[1/(1-c1+c1t1)][c0-c1t0+I+G]
b. The multiplier=1/(1-c1+c1t1)<1/(1-c1), so the economy responds less to changes in
autonomous spending when t1 is positive. After a positive change in autonomous
spending, the increase in total taxes (because of the increase in income) tends to lessen
the increase in output. After a negative change in autonomous spending, the fall in total
taxes tends to lessen the decrease in output.
c. Because of the automatic effect of taxes on the economy, the economy responds less to
changes in autonomous spending than in the case where taxes are independent of income.
Since output tends to vary less (to be more stable), fiscal policy is called an automatic
stabilizer.
5. a. In the diagram representing goods market equilibrium, the ZZ line shifts up. Output
increases.
b. There is no effect on the diagram or on output.
c. The ZZ line shifts up and output increases. Effectively, the income transfer increases the
propensity to consume for the economy as a whole.
d. The propensity to consume is likely to be higher for low-income taxpayers. Therefore,
tax cuts will be more effective at stimulating output if they are directed toward low-
income taxpayers.
6. a. Y=[1/(1-c1+c1t1)][c0-c1t0+I+G]
b. T = t0 + t1[1/(1-c1+c1t1)][c0-c1t0+I+G]
c. Both Y and T decrease.
d. If G is cut, Y decreases even more. A balanced budget requirement amplifies the
effect
of the decline in c0. Therefore, such a requirement is destabilizing.
7. a. Y increases by 1/(1-c1)
b. Y decreases by c1/(1-c1)
c. The answers differ because spending affects demand directly, but taxes affect demand
indirectly through consumption, and the propensity to consume is less than one.
d. The change in Y equals 1/(1-c1) - c1/(1- c1)=1. Balanced budget changes in G and T are
not macroeconomically neutral.
e. The propensity to consume has no effect because the balanced budget tax increase aborts
the multiplier process. Y and T both increase by one unit, so disposable income, and
hence consumption, do not change.
8. a. Y=C+I+G
Y=[1/(1-c1-b1)]*[c0-c1T+b0+G]
b. Including the b1Y term in the investment equation increases the multiplier.
Increases in
autonomous spending now create a multiplier effect through two channels: consumption
and investment. For the multiplier to be positive, the condition c1+b1<1 is required.
c. Output increases by b0 times the multiplier. Investment increases by the change in
b0
plus b1 times the change in output. The change in business confidence leads to an
increase in output, which induces an additional increase in investment. Since
investment increases, and saving equals investment, saving must also increase. The
increase in output leads to an increase in saving.
Explore Further
9. a. Equilibrium output will fall in the short run
b. A cut in G of will have a larger impact on equilibrium GDP than the same size increase
in T
c. The statement is accurate for any value of the marginal propensity to consume.
d. As the deficit is reduced, the value of c0 increases as consumer confidence increases. This
will increase equilibrium GDP.
10. a. Output will fall.
b. Since output falls, investment will also fall. Public saving will not change. Private
saving will fall, since investment falls, and investment equals saving. Since output and
consumer confidence fall, consumption will also fall.
c. Output, investment, and private saving would have risen.
d. Clearly this logic is faulty. When output is low, what is needed is an attempt by
consumers to spend more. This will lead to an increase in output, and
therefore—somewhat paradoxically—to an increase in private saving. Note, however,
that with a linear consumption function, the private saving rate (private saving divided by
output) will fall when c0 rises.
11. a. $450 B
b. $225 B
c. $450 B
d. $450 B
10. a. Percentage change in GDP = 176.5 − 281.44/281.44 × 100 = −37.29%
b. Multiplier = 1/1 − 0.6 = 2.5; to avoid the decline of GDP by €104.94, autonomous
expenditure should have increased by €41.976 or €104.94/2.5
c. Further cuts in government expenditure would have had a greater multiplier effect on the
slowdown of GDP, further accelerating the economic meltdown.
d. GDP increases by 15.5 × 2.5 = €38.75 billion
11. a. Equilibrium output will fall in the short run
b. A cut in G of will have a larger impact on equilibrium GDP than the same size increase in
T
c. The statement is accurate for any value of the marginal propensity to consume.
d. As the deficit is reduced, the value of c 0 increases as consumer confidence increases. This
will increase equilibrium GDP.