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Aggregate Expenditure Analysis Practice

This document contains a practice test on aggregate expenditure and the multiplier model from an economics textbook. It includes 10 multiple choice questions testing understanding of concepts like GDP, the multiplier effect, and how changes in factors like government spending, consumption, and inflation affect aggregate expenditure. It also contains short answer questions using a table to analyze equilibrium GDP, the marginal propensity to consume, and how much government spending would need to change to reach full employment GDP.

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59 views3 pages

Aggregate Expenditure Analysis Practice

This document contains a practice test on aggregate expenditure and the multiplier model from an economics textbook. It includes 10 multiple choice questions testing understanding of concepts like GDP, the multiplier effect, and how changes in factors like government spending, consumption, and inflation affect aggregate expenditure. It also contains short answer questions using a table to analyze equilibrium GDP, the marginal propensity to consume, and how much government spending would need to change to reach full employment GDP.

Uploaded by

Joey YU
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd

ECON1220 Chapter5 Practice Aggregate Expenditure

I. Multiple Choices
1) Consumption spending is $5 million, planned investment spending is $8 million,
unplanned investment spending is $2 million, government purchases are $10 million,
and net export spending is $2 million. What is GDP?
A) $15 million B) $23 million C) $25 million D) $27 million

2) Potential GDP equals $500 billion. The economy


is currently producing GDP1 which is equal to $450
billion. If the MPC is 0.8, then how much must
autonomous spending change for the economy to
move to potential GDP?
A) -$40 billion B) -$10 billion
C) $10 billion D) $40 billion

3) Consumption is $5 million, planned investment spending is $8 million, government


purchases are $10 million, and net exports are equal to $2 million. If GDP during that
same time period is equal to $23 million, what unplanned changes in inventories
occurred?
A) There was an unplanned increase in inventories equal to $2 million.
B) There was no unplanned change in inventories.
C) There was an unplanned decrease in inventories equal to $2 million.
D) There was an unplanned decrease in inventories equal to $19 million.

4) If disposable income falls by $50 billion and consumption falls by $40 billion, then
the slope of the consumption function is
A) 1.20. B) 0.80. C) 0.70. D) 0.10.

5) If inflation in the United States is higher than inflation in other countries, what will
be the effect on net exports for the United States?
A) Net exports will rise as U.S. exports increase.
B) Net exports will rise as U.S. imports decrease.
C) Net exports will decrease as U.S. exports decrease.
D) Net exports will decrease as U.S. imports decrease.

6) If the marginal propensity to save is 0.1, then a $10 million decrease in disposable
income will
A) increase consumption by $9 million. B) increase consumption by $1 million.
C) decrease consumption by $9 million. D) decrease consumption by $1 million.
1
ECON1220 Chapter5 Practice Aggregate Expenditure

7) At point L in the figure above, which of


the following is true?
A) Aggregate expenditure is greater than
GDP.
B) The economy has achieved
macroeconomic equilibrium.
C) Actual inventories are greater than
planned inventories.
D) GDP will be increasing.

8) Suppose that government spending increases,


shifting up the aggregate expenditure line. GDP
increases from GDP1 to GDP2, and this amount
is $400 billion. If the MPC is 0.75, then what is
the distance between N and L or by how much
did government spending change?
A) $10 billion B) $100 billion
C) $200 billion D) $300 billion

9) All of the following are true statements about the multiplier except
A) The formula for the multiplier overstates the real world multiplier when we take
into account the impact of changes in GDP on imports, inflation and the interest rate.
B) The larger the MPC, the larger the multiplier.
C) The multiplier is the ratio of the change in real GDP to the change in autonomous
expenditure.
D) The multiplier makes the economy less sensitive to changes in autonomous
expenditure.

10) Which of the following is a reason why increases in the price level result in a
decline in aggregate expenditure?
A) Price level increases raise real wealth, which causes consumption spending and
aggregate expenditure to decline.
B) Price level increases cause firms and consumers to hold more money, which raises
the interest rate. Higher interest rates lower consumption and planned investment
expenditures, which lowers aggregate expenditure.
C) Price level increases in the United States relative to other countries raise net
exports, which lowers aggregate expenditure.
D) As the price level rises, government spending falls, which lowers aggregate
2
ECON1220 Chapter5 Practice Aggregate Expenditure

expenditure.
II. Short Answer Questions

Using the table above, answer the following questions. The numbers in the table are in
billions of dollars.
a. What is the equilibrium level of real GDP?

b. What is the MPC?

c. If potential GDP is $4,000 billion, is the economy at full employment? If not, what
is the condition of the economy?

d. If the economy is not at full employment, by how much should government


spending increase so that the economy can move to the full employment level of
GDP?

Common questions

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Autonomous spending must increase by $10 billion to move the current GDP from $450 billion to the potential GDP of $500 billion. This is calculated using the formula for the spending multiplier: 1/(1-MPC) = 1/0.2 = 5. The needed change in GDP is $50 billion ($500 billion - $450 billion), thus the change in autonomous spending must be $50 billion / 5 = $10 billion.

The slope of the consumption function, which is the marginal propensity to consume (MPC), is 0.8. This is calculated by dividing the change in consumption by the change in disposable income: $40 billion / $50 billion = 0.8.

If disposable income falls by $10 million, consumption will decrease by $9 million since the marginal propensity to consume (MPC) is 0.9 (which is 1 - MPS of 0.1). Therefore, the change in consumption is MPC multiplied by the change in income: 0.9 x $10 million = $9 million.

Government spending would need to increase by $100 billion. The spending multiplier is calculated as 1/(1-MPC) = 4. Therefore, to raise GDP by $400 billion, the required change in government spending is $400 billion / 4 = $100 billion.

Higher inflation in the United States compared to other countries will decrease U.S. net exports. This is because U.S. goods become relatively more expensive for foreign buyers, reducing exports, while the U.S. may import more due to foreign goods being cheaper, resulting in a decline in net exports.

The unplanned change in inventories would be zero because the sum of consumption spending, planned investment, government purchases, and net export spending equals GDP exactly ($5 million + $8 million + $10 million + $2 million = $25 million). This indicates no unplanned inventory change because the aggregate expenditure equals the GDP.

When U.S. inflation is higher than that of other countries, its goods become less competitive internationally as they are relatively more expensive, leading to a decrease in exports and adversely affecting the trade balance.

An increase in the price level leads to higher interest rates as firms and consumers hold more money. This results in a decrease in both consumption and planned investment expenditures, thus reducing aggregate expenditure.

If the equilibrium GDP is lower than potential GDP, the economy is operating below full employment, indicating the presence of a recessionary gap. This means there are underutilized resources and higher unemployment than the natural rate.

The real-world impact of the multiplier is often lower than theoretical predictions due to the influence of changes in GDP on imports, inflation, and interest rates, which are not considered in simple theoretical models. These factors can diminish the effectiveness of fiscal stimulus compared to initial estimates.

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