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MBF - 23e - SMChap031 - Tutorial 6 Solution

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MBF - 23e - SMChap031 - Tutorial 6 Solution

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Cheong Choon Sing
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Chapter 31 - The Aggregate Expenditures Model

Chapter 31 - The Aggregate Expenditures Model

McConnell Brue Flynn 23e

DISCUSSION QUESTIONS

1. What is an investment schedule and how does it differ from an investment demand
curve? LO31.2

Answer: An investment schedule shows the level of investment spending for a


given level of GDP. An investment demand curve shows how expected rates of
profit and real interest rates determine the level of investment spending. In the
simple AE model, investment spending is assumed to be independent of the level
of real GDP.

2. If the multiplier is 5 and investment increases by $3 billion, equilibrium real GDP


will increase by: LO31.5
a. $2 billion.
b. $3 billion.
c. $8 billion.
d. $15 billion.
e. none of the above.

Answer: $15 billion

Feedback: Equilibrium GDP will increase by $15 billion. We know this is true
because the change in equilibrium GDP is equal to the value of the multiplier
times the change in investment. For the numbers given in this problem, the
change in equilibrium GDP will be 5 × $3 billion, or $15 billion.

PROBLEMS

1. Assuming the level of investment is $16 billion and independent of the level of total
output, complete the following table and determine the equilibrium levels of output
and employment in this private closed economy. What are the values of the MPC and
MPS? LO31.3

31-1
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Chapter 31 - The Aggregate Expenditures Model

Answer: Saving: $ −4; 0; 4; 8; 12; 16; 20; 24; 28; equilibrium output = 340;
equilibrium employment = 65; MPC = 0.8; MPS = 0.2

Feedback: The savings column is found by subtracting consumption from real


domestic output (disposable income) for each row. The answers are reported in
the savings column above. We can also find aggregate expenditures by adding
consumption and investment, which is reported in the last column of the table. We
can find equilibrium two ways. First, we can find the level of output and
employment where investment equals saving. Second, we can find the level of
output and employment where aggregate expenditures equal real output. Either of
these approaches will give us the equilibrium level of output of $340 billion and a
level of employment 65 million.

The marginal propensity to consume can be found by dividing the change in


consumption by the change in real domestic output:

The marginal propensity to save can be found by subtracting the marginal


propensity to consume from one:

Possible levels Real domestic


of output Aggregate
employment (GDP = DI) Consumption Saving Investment Expenditures
(millions) (billions) (billions) (billions) (billions) (billions)
40 $240 $244 −$4 $16 $260
45 260 260 0 16 276
50 280 276 4 16 292
55 300 292 8 16 308
60 320 308 12 16 324
31-2
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
Chapter 31 - The Aggregate Expenditures Model

Possible levels Real domestic


of output Aggregate
employment (GDP = DI) Consumption Saving Investment Expenditures
(millions) (billions) (billions) (billions) (billions) (billions)
65 340 324 16 16 340
70 360 340 20 16 356
75 380 356 24 16 372
80 400 372 28 16 388

2. Refer to the accompanying table in answering the questions that follow: LO31.8

a. If full employment in this economy is 130 million, will there be an inflationary


expenditure gap or a recessionary expenditure gap? What will be the consequence
of this gap? By how much would aggregate expenditures in column 3 have to
change at each level of GDP to eliminate the inflationary expenditure gap or the
recessionary expenditure gap? What is the multiplier in this example?
b. Will there be an inflationary expenditure gap or a recessionary expenditure gap if
the full-employment level of output is $500 million? By how much would
aggregate expenditures in column 3 have to change at each level of GDP to
eliminate the gap? What is the multiplier in this example?
c. Assuming that investment, net exports, and government expenditures do not
change with changes in real GDP, what are the sizes of the MPC, the MPS, and
the multiplier?

Answer:
a. Recessionary expenditure gap; $20 million shortfall of aggregate expenditure;
$20 million; 5
b. Inflationary expenditure gap; −$20 million; 5
c. MPC = 0.8; MPS = 0.2; multiplier = 5

Feedback:
a. The equilibrium in this economy is at $600 million, where real domestic
output equals aggregate expenditures (this is where the economy will take us).
Since full employment is at 130 million, this implies that full employment real
domestic output is at $700 million. Given that aggregate expenditures are only
$680 million at this level of employment we have a recessionary expenditure

31-3
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
Chapter 31 - The Aggregate Expenditures Model

gap. That is, aggregate expenditures are $20 million below real domestic
output.

If aggregate expenditures increased by $20 million, the new equilibrium


would be at $700 million, which is at full employment (add $20 million to
each level of aggregate expenditures in the table above). The multiplier can be
found by dividing the change in equilibrium real domestic output by the
change in aggregate expenditures.

b. Again, the equilibrium in this economy is at $600 million, where real


domestic output equals aggregate expenditures. Since full-employment real
domestic output is $500 million and given that aggregate expenditures are
$520 million at this level of real domestic output, we have an inflationary
expenditure gap. That is, aggregate expenditures are $20 million above real
domestic output.

For this case, if aggregate expenditures decreased by $20 billion, the new
equilibrium would be at $500 million, which is at full employment (subtract
$20 million from each level of aggregate expenditures in the table above). The
multiplier can be found by dividing the change in equilibrium real domestic
output by the change in aggregate expenditures.

(Note the changes are negative in this case)

c. To find the marginal propensity to consume (MPC), divide the change in


aggregate expenditures by the change in real domestic output (assuming that
investment, net exports, and government expenditures do not change with
changes in real GDP).

With the MPC, we can find the marginal propensity to save (MPS).

We can also use the MPC (or MPS) to find the multiplier.

This is consistent with the answers above.

31-4
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