Chapter 25 Solutions to Problems Demand-Side Equilibrium: Unemployment or Inflation?

Transcription

1 Chapter 25 Solutions to Problems Demand-Side Equilibrium: Unemployment or Inflation? 1. Some problems are created by the trade deficit. Since net exports are a component of aggregate demand, the trade deficit represents a reduction in aggregate demand. On the other hand, there are some advantages to the trade deficit. (These features will be discussed in future chapters. The trade deficit allows U.S. absorption of goods and services to exceed production. Also, it facilitates the inflow of foreign capital that covers the shortage of savings that would otherwise be caused by a federal government deficit). 2. At any level of GDP other than the single equilibrium, total spending differs from the amount of production. Hence inventories change, and producers have an incentive to change the level of output. 3. FIGURE 25-1 The equilibrium GDP is 3,800, where spending equals output. This is shown by the intersection of the expenditure line, E, with the 45 degree line. The MPC calculated from the data is.90, so the multiplier is 10. If investment spending rises by $20 to $260 the equilibrium GDP will increase by $20 *10=$200 (this is represented by a vertical shift of the expenditure function of $20.

2 4. In question 4, the marginal propensity to consume is lower than it was in question 3 (0.6 versus 0.9), but in this case there is induced investment (investment which changes as GDP changes), while in question 3 investment was constant. The two changes cancel each other, and the expenditure schedule is the same in both questions. So Figure 25-1 applies to Question 4, and the equilibrium GDP is FIGURE 25-2 At lower prices, the real value of money and other assets that are denominated in money terms is higher. Since wealth influences consumption, at lower prices consumption is higher. 6. The answer depends upon the current state of the economy. 7. Y = C + I + G + (X - IM) C = DI C = (Y ) C = Y C = Y Y = Y Y = 0.75Y Y= 1500 Y = (1/0.25) 1500 Y = = 6000 This algebraic model yields the same equilibrium GDP as Table 25-2 and Figure 25-3 in the text. (The solution is also given in the Appendix.) 8. Y = C + I + G + (X - IM) C = DI C = (Y ) C = Y - 900

3 C = Y Y = Y Y = 0.75Y Y= 1700 Y = (1/0.25) 1700 Y = = 6800 This algebraic model yields the same equilibrium GDP as Table 25-3 and Figure 25-9 in the text. This question demonstrates that the multiplier applies to changes in I as well as changes in C. 9. Y = C + I + G + (X - IM) C = (Y ) C = Y C = Y Y = Y Y = Y 0.2Y= 1100 Y = 5(1100) = 5500 The multiplier is 5. If G rises by $100, Y will increase by $500 (5 $100). 5-3 and Figure 25-9 in the text. This question demonstrates that the multiplier applies to changes in I as well as changes in C. If G and T each increase by $100 Y will increase by $100 as demonstrated below: Y = C + I + G + (X - IM) C = (Y ) C = Y C = Y Y = Y Y = Y 0.2Y= 1120 Y = 5(1120) = The answers will, of course, vary. Most students probably spent their last dollar at a retail store. The money went into the pocket of the proprietor, an employee or a supplier of the store, who probably spent some portion of it on other goods or services. 11. FIGURE 25-3

4 Before Shift After Shift Income Consumption Expenditure Consumption Expenditure Equilibrium GDP has risen from 1320 to The oversimplified multiplier formula can be used. The marginal propensity to consume can be calculated between any two income levels, e.g., MPC = ( )/( ) = 40/60 = 2/3 The formula then calculates the multiplier as 1/[1 - (2/3)] = 3. So a shift in consumption of 40 raises equilibrium GDP by 120. Answers to Appendix A Questions 1. Y = C + I + G + (X - IM) C = (Y - 400) C = Y C = Y Y = Y Y = 0.75Y Y= 500

5 Y = = Y = C + I + G + (X - IM) C = DI C = (Y - 400) C = Y C= Y Y = :5Y Y = 0.5Y Y= 700 Y = (1/0.5) 700 Y = = Saving is equal to disposable income minus consumption. In question 1: S = (Y - T) - C S = ( ) - [ (2000)] S = ( ) S = S = 250 S is not equal to I, but S is equal to I + (X - IM) + (G - T). In question 2: S = (Y - T) - C S = ( ) - [ (1400)] S = ( ) S = S = 250 In this case, S = I, because (X - IM) and (G - T) are both zero. 4. (a) Y = C + I + G + (X - IM) C = (Y - 200) C = Y C = Y Y = Y Y = 0.75Y Y= 700 Y = (1/0.25) 700 Y = = 2800 (b) There is a recessionary gap of 200. (c) The last five lines in 4(a) above are replaced by: Y = Y Y = 0.75Y Y= 800 Y = (1/0.25) 800 Y = = 3200 (d) There is now an inflationary gap of 200.

6 5. (a) Y = C + I + G + (X - IM) C = (Y - 500) C = Y C = Y Y= Y Y = 0.8Y Y = 900 Y = (1/0.2) 900 Y = = 4500 (b) S = (Y - T) - C S = ( ) - [ (4500)] S = = 700 S = I (c) The last five lines of 5(a) above are replaced by: Y = Y Y = 0.8Y Y = 1000 Y = (1/0.2) 1000 Y = = 5000 S = (Y - T) - C S = ( ) - [ (5000)] S = = 800 S is not equal to I, but S = I + (X - IM) Answers to Appendix B Questions 1. GDP Exports Imports Net Exports In Figure 25-4, the intersection of the lower expenditure line with the 45-degree line shows an equilibrium GDP of 4,000. FIGURE 25-4

7 3. In Figure 25-4, the intersection of the upper expenditure line with the 45-degree line shows an equilibrium GDP of 4,500. Exports have risen by 250, and GDP has risen by 500, so the multiplier is 2.