Answered: Consider two closed economies that are…

Economics:

10th Edition

ISBN:9781285859460

Author:BOYES, William

Publisher:BOYES, William

Chapter9: Aggregate Expenditures

Section: Chapter Questions

Problem 7E

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Question

Consider two closed economies that are identical except for their marginal propensity to consume (MPC). Each economy is currently in equilibrium with real GDP and total expenditure equal to $100 billion, as shown by the black points on the following two graphs. Neither economy has taxes that change with income. The grey lines show the 45-degree line on each graph.

The first economy's MPC is 0.5. Therefore, its initial total expenditure line has a slope of 0.5 and passes through the point (100, 100).

The second economy's MPC is 0.70. Therefore, its initial total expenditure line has a slope of 0.70 and passes through the point (100, 100).

Now, suppose there is an increase of $30 billion in investment in each economy.

Place a green line (triangle symbol) on each of the previous graphs to indicate the new total expenditure line for each economy. Then place a black point (plus symbol) on each graph showing the new level of equilibrium output. (Hint: You can see the slope and vertical axis intercept of a line on the graph by selecting it.)

In the first economy (with MPC = 0.5), the $30 billion increase in investment causes equilibrium output to increase by (fill in the blank) billion. In the second economy (with MPC = 0.70), the $30 billion increase in investment causes equilibrium output to increase by (fill in the blank) billion. Therefore, a higher MPC is associated with a (higher or lower) multiplier.

Now, confirm your graphical analysis algebraically using the oversimplified multiplier formula:

Multiplier = 1/(1-MPC)

For the first economy, with an MPC of 0.5, the effect of the $30 billion increase in investment is as follows:

Change in equilibrium output	=	Change in Total ExpenditureChange in Total Expenditure ×	Multiplier
	=	(+30 billion, -30 billion, +60 billion, or -60 billion) ×	1/(1-0.70) OR 1/(1-0.50) OR 1(1-0.70) OR 1(1-0.50)
	=	(+30 billion, -30 billion, +60 billion, or -60 billion) ×	(Fill in the blank)
	=	(+30 billion, -30 billion, +60 billion, or -60 billion) ×

Using the same method, the multiplier for the second economy is (0.59, 2, 0.3, 0.70, or 3.33).

the graph by selecting it.)
TOTAL EXPENDITURE (Billions of dollars)
200
180
160
100
R
D
JOC
AE Line
140
MPC=0.5
45-Degree Line
80 100 120 140
REAL GDP (Billions of dollars)
160 180
200
unum output. (Hint: You can see the slope and vertical
New AE Line
New Equilibrium
0

S
TOTAL EXPENDITURE (Billions of dollars)
180
180
140
80
40
0
0
JOJO
AE Line
20
40
MPC=0.70
45-Degree Line
140
100
REAL GDP (Billions of dollars)
180 200
A
New AE Line
New Equilibrium
Ⓡ
In the first economy (with MPC = 0.5), the $30 billion increase in investment causes equilibrium output to increase by
economy (with MPC = 0.70), the $30 billion increase in investment causes equilibrium output to increase by S

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