Tackle the Test: Free-Response Questions

1. Question

   Assume the MPC in an economy is 0.8 and the government increases government purchases of goods and services by $60 million. Also assume the absence of taxes, international trade, and changes in the aggregate price level.

   
   

   
   

   1. What is the value of the spending multiplier?

      
      
   
   

   2. By how much will real GDP change as a result of the increase in government purchases?

      
      
   
   

   3. What would happen to the size of the effect on real GDP if the MPC fell? Explain.

      
      
   
   

   4. If we relax the assumption of no taxes, automatic changes in tax revenue as income changes will have what effect on the size of the spending multiplier?

      
      
   
   

   5. Suppose the government collects $60 million in taxes to balance its $60 million in expenditures. By how much would real GDP change as a result of this increase in both government spending and taxes?

      
      
   
   

   Rubric for FRQ 1 (6 points)

   1 point: Spending multiplier = 1/(1 − MPC) = 1/(1 − 0.8) = 1/0.2 = 5

   1 point: $60 million × 5 = $300 million

   1 point: It would decrease.

   1 point: The spending multiplier is 1/(1 − MPC). A fall in MPC increases the denominator, (1 − MPC), and therefore decreases the spending multiplier.

   1 point: Decrease it

   1 point: $60 million × 1 = $60 million

2. Page 217

   Question

   A change in government purchases of goods and services results in a change in real GDP equal to $200 million. Assume the absence of taxes, international trade, and changes in the aggregate price level.

   
   

   
   

   1. Suppose that the MPC is equal to 0.75. What was the size of the change in government purchases of goods and services that resulted in the increase in real GDP of $200 million?

      
      
   
   

   2. Now suppose that the change in government purchases of goods and services was $20 million. What value of the spending multiplier would result in an increase in real GDP of $200 million?

      
      
   
   

   3. Given the value of the spending multiplier you calculated in part b, what marginal propensity to save would have led to that value of the spending multiplier? (3 points)

      
      
   
   

   Rubric for FRQ 2 (3 points)

   1 point: $50 million

   (spending multiplier = 1/(1 − MPC ) =

   1/(1 − 0.75) = 1/0.25 = 4; change in G × 4 =

   $200 million; change in G = $50 million)

   1 point: 10

   ($20 × spending multiplier = $200 million;

   spending multiplier = 200/20 = 10)

   1 point: 0.1

   (1/(1 − MPC ) = 1/MPS = 10; MPS = 0.1)