QUESTIONS AND PROBLEMS

Check Your Understanding

Question 8.1

1. Describe the important difference between the average propensity to consume (APC) and the marginal propensity to consume (MPC).

Question 8.2

2. List the factors that influence an individual’s marginal propensity to consume.

Question 8.3

3. Explain why we wouldn’t expect investment to grow sufficiently to pull the economy out of a depression.

Question 8.4

4. Define the multiplier effect. Describe why a multiplier exists.

Question 8.5

5. Explain why a $100 reduction in taxes does not have the same impact on output and employment as a $100 increase in government spending.

Question 8.6

6. How do injections and withdrawals into an economy affect its income and output?

Apply the Concepts

Question 8.7

7. Assume a simple Keynesian depression economy with a multiplier of 4 and an initial equilibrium income of $3,000. Saving and investment equal $400, and assume full employment income is $4,000.

  1. What is the MPC equal to? The MPS?

  2. How much would government spending have to rise to move the economy to full employment?

  3. Assume that the government plans to finance any spending by raising taxes to cover the increase in spending (it intends to run a balanced budget). How much will government spending and taxes have to rise to move the economy to full employment?

  4. From the initial equilibrium, if investment grows by $100, what will be the new equilibrium level of income and savings?

Question 8.8

8. Other than reductions in interest rates that increase the level of investment by businesses, what factors would result in higher investment?

Question 8.9

9. The simple aggregate expenditures model argues that one form of spending is just as good as any other; increases in all types of spending lead to equal increases in income. Is there any reason to suspect that private investment might be better for the economy than government spending?

Question 8.10

10. Assume that the economy is in equilibrium at $5,700, and full employment is $4,800. If the MPC is 0.67, how big is the inflationary gap?

Question 8.11

11. How does the economy today differ from that of the Great Depression, the economy Keynes used as the basis for the macroeconomic model discussed in this chapter?

Question 8.12

12. In modern politics, the word “Keynesian” often is synonymous with “big government” spending. Does this characterization accurately reflect the role of government in spurring economic activity? How would a tax cut be characterized today versus in Keynes’s time?

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In the News

Question 8.13

13. In recent years banks have encouraged their customers to save by giving incentives to join programs that automatically transfer money from checking accounts to savings accounts. For example, a bank might offer to round debit transactions to the nearest dollar, transferring the change to one’s savings account, and then boost this amount with a match up to a certain amount. Although these programs were intended to encourage customers to save, some economists are not very enthusiastic about these programs. What reasons, both practical and theoretical, might cause some to be concerned?

Question 8.14

14. The Affordable Care Act (a.k.a. Obamacare) is one of the largest government programs to be implemented in recent years, and involves the use of government subsidies to increase the percentage of Americans with health insurance. Explain how the increase in government spending may lead to a multiplier effect. How might this multiplier be affected if taxes are raised to finance the increased government spending?

Solving Problems

Question 8.15

15. Using this aggregate expenditures table, answer the questions that follow.

Income (Y), in $ Consumption (C), in $ Saving (S), in $
2,200 2,320 −120
2,300 2,380 −80
2,400 2,440 −40
2,500 2,500 0
2,600 2,560 40
2,700 2,620 80
2,800 2,680 120
2,900 2,740 160
3,000 2,800 200

  1. Compute the APC when income equals $2,300 and the APS when income equals $2,800.

  2. Compute the MPC and MPS.

  3. What does the multiplier equal?

  4. If investment spending is equal to $120, what will be equilibrium income?

  5. Using the following graph, show saving, investment, and equilibrium income.

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WORK IT OUT | interactive activity

Question 8.16

16. Use the figure to answer the following questions.

  1. What are the MPC, the MPS, and the multiplier?

  2. If the economy is currently in equilibrium at point a, and full employment income is $4,000, how much in additional expenditures is needed to move this economy to full employment? What is this level of spending called?

  3. Assume that the economy is currently in equilibrium at point a and full employment income is $4,000. How much of a tax decrease would be required to move the economy to full employment?

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USING THE NUMBERS

Question 8.17

17. According to By the Numbers, in the year 2015, by how much did total food and grocery consumption exceed total gasoline and energy consumption? Based on your knowledge of how food and gas prices have changed since 2015, how would this difference in spending change?

Question 8.18

18. According to By the Numbers, the U.S. government spends less per person than any other developed country on the list. Does this mean that the overall size of the U.S. government is smaller than that of the other developed countries? Why or why not?