Question

For all the questions below select the appropriate answer:

a)

If the MPC is 3/4, the net tax rate is 1/3, and the government increases spending by $100 million, then we would expect the result to be: an increase in real GDP of $200 million. no change in equilibrium real GDP. an increase in equilibrium real GDP of $250 million. a reduction in equilibrium real GDP of $400 million.

b)

Suppose the MPC and the slope of the AE function are 0.8, giving a multiplier of 5.0. Then a newly formed government introduces a net tax on national income, NT = 0.2Y. As a result: the slope of the AE function is unchanged, the multiplier remains 5.0 and equilibrium national income is not affected. the slope of the AE function increases to 1.0, the multiplier and equilibrium national income both increase. the slope of the AE function decrease to 0.64, the multiplier decreases to 2.78 and equilibrium national income decreases. the slope of the AE function decreases to 0.64, the multiplier decreases to 1.56 and equilibrium national income decreases.

c)

In an open economy with imports described by the import function: IM = 0.25Y and exports equal to X = 250: exports would be greater than imports at all levels of GDP. if real GDP were 1600 net exports would be zero. in a diagram the net export function would have a vertical intercept of 250 and a slope (ΔIM/ΔY) of - 0.25. the net export function would be NX = 250 + 0.25Y.

d)

In the diagram NT is tax revenue and G is government expenditure. All figures are in billions. In this economy: tax revenues, government spending and the budget balance all vary directly with GDP. tax revenues, government spending and the budget balance all vary inversely with GDP. tax revenues vary directly with GDP, but government spending and the budget balance are independent of GDP. government spending is independent of GDP, but tax revenues and the budget balance vary directly with GDP.

e)

An economy with household, business, government and international trade sectors is described by the following equations: Consumption: C = 75 + 0.85(Y - T) Investment: I = 125 Government expenditure: G = 75 Net taxes: NT = 0.2Y Exports: X = 25 Imports: IM = 0.18Y The multiplier, the equilibrium level of real GDP and the government's budget balance in this economy would be: 1.5, 375 and a balanced budget (BB = 0). 6.67, 2000 and a surplus of 325 (BB = 325). 2.0, 600 and a surplus of 45 (BB = 45). 3.03, 909 and a deficit of 182 (BB = - 182).

Answer 1

a) an increase in real GDP of $200 million.
(According to multiplier formula,
Change in GDP/Change in G = 1/(1-MPC + MPC*t) = 1/[1-(3/4)+(3/4)*(1/3)] = 1/[(1/4)+(1/4)] = 1/0.5 = 2
So, Change in GDP = Change in G*2 = 100*2 = 200)

b) the slope of the AE function decrease to 0.64, the multiplier decreases to 2.78 and equilibrium national income decreases.
(MPC*Yd = 0.8(Y-NT) = 0.8(Y-0.2Y) = 0.8(0.8Y) = 0.64Y
So, Slope = 0.64
Multiplier = 1/(1-MPC + MPC*t) = 1/[1-0.8+0.8*0.2) = 1/(0.2+0.16) = 1/0.36 = 2.78. So, as multiplier decreases, national income also decreases.)

c) in a diagram the net export function would have a vertical intercept of 250 and a slope (ΔIM/ΔY) of - 0.25.
(NX = X - IM = 250 - 0.25Y
So, vertical intercept = 250 and slope = d(NX)/dY = -0.25)

d) government spending is independent of GDP, but tax revenues and the budget balance vary directly with GDP.
(G is independent but T and BB vary directly with GDP.)

e) 2.0, 600 and a surplus of 45 (BB = 45).
(Equilibrium occurs where Y = C + I + G + X - IM = C = 75 + 0.85(Y - 0.2Y) + 125 + 75 + 25 - 0.18Y
So, Y = 300 + 0.68Y - 0.18Y = 300 + 0.5Y
So, Y - 0.5Y = 0.5Y = 300
So, Y = 300/0.5 = 600
So, option 'c' is correct.