Part-2 Chapter-9

Aplia Homework: Demand-Side Equilibrium: Unemployment or Inflation?

1. Aggregate expenditure and income

The following table shows consumption (CC), investment (II), government purchases (GG), and net exports (X−IMX−IM) in a hypothetical economy for various levels of real GDP (YY). Assume that the price level remains unchanged at all levels of income. All figures are in billions of dollars.

Compute total expenditure for each income level, and fill in the last column in the following table.

The following graph shows income (Y) on the horizontal axis and total expenditure (TE) on the vertical axis. The grey line represents a 45-degree (Y=TE) line.

Use the blue points (circle symbol) to plot the total expenditure line for this economy at an income of $500 billion, $600 billion, $700 billion, $800 billion, and $900 billion.

Note: Plot your points in the order in which you would like them connected. Line segments will connect the points automatically.

Suppose real GDP is currently $900 billion. Assuming the price level remains constant, this would mean that __________, which would send a signal to firms to ________.

The marginal propensity to consume (MPC) for this economy is _______, and the oversimplified multiplier for this economy is equal to _______.

2. Expenditure gaps

The following graph shows the total expenditure line (TE) for an economy where current equilibrium output is $350 billion and potential output is $100 billion.

The economy is experiencing ______ equal to ______ billion. To close the output gap, government purchases could ______by _____ billion. Thus, the value of the multiplier for this economy is ______.

On the previous graph, shift the TE line to show the change in total expenditure necessary to close the output gap.

Note: Select and drag the curve to the desired position. The curve will snap into position, so if you try to move a curve and it snaps back to its original position, just drag it a little farther.

3. The multiplier and the MPC

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 0.75. Therefore, its initial total expenditure line has a slope of 0.75 and passes through the point (100, 100).

Now, suppose there is a decrease of $20 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 $20 billion decrease in investment causes equilibrium output to decrease by ______ billion. In the second economy (with MPC = 0.75), the $20 billion decrease in investment causes equilibrium output to decrease by ______ billion. Therefore, a lower MPC is associated with a ______ multiplier.

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

For the first economy, with an MPC of 0.5, the effect of the $20 billion decrease in investment is as follows:

Using the same method, the multiplier for the second economy is ________.

4. The multiplier effect of a change in government purchases

Consider a hypothetical closed economy in which households spend $0.70 of each additional dollar they earn and save the remaining $0.30.

The marginal propensity to consume (MPC) for this economy is _______, and the oversimplified multiplier for this economy is _______.

Suppose the government in this economy decides to decrease government purchases by $300 billion. The decrease in government purchases will lead to a decrease in income, generating an initial change in consumption equal to _______. This decreases income yet again, causing a second change in consumption equal to ________. The total change in demand resulting from the initial change in government spending is _______.

The following graph shows the aggregate demand curve ( AD1 ) for this economy before the change in government spending.

Use the green line (triangle symbol) to plot the new aggregate demand curve ( AD2 ) after the multiplier effect takes place. For simplicity, assume that there is no “crowding out.”

Hint: Be sure that the new aggregate demand curve ( AD2 ) is parallel to the initial aggregate demand curve ( AD1 ). You can see the slope of  AD1  by selecting it on the graph.

5. Algebra of the income-expenditure model

Consider a small economy that is closed to trade, so its net exports are equal to zero. Suppose that the economy has the following consumption function, where C is consumption, Y is real GDP, I is investment, G is government purchases, and T is for net taxes:

C          =                     40+0.5× (Y−T) 

Suppose G = $165 billion, I = $50 billion, and T = $10 billion.

Given the consumption function and the fact that, in a closed economy, total expenditure can be calculated as Y=C+I+G, the equilibrium output level is ______ billion.

Suppose the government purchases are increased by $150 billion. The new equilibrium level of output will be equal to ______ billion.

Based on the effect of the change in government purchases on equilibrium output, you can tell that this economy's spending multiplier is equal to ______.