Chapter 27 - Basic Macroeconomic Relationships

Chapter 27 Basic Macroeconomic Relationships

PROBLEMS

1. Refer to the incomplete table below. LO1

a. Fill in the missing numbers in the table.

b. What is the break-even level of income in the table? What is the term that economists use for the saving situation shown at the $240 level of income?

c. For each of the following items indicate whether the value in the table is either constant or variable as income changes: the MPS, the APC, the MPC, the APS.

Answers: (a) data in the completed table; (b) $260, dissaving; (c) constant, variable, constant, variable.

2. Suppose that disposable income, consumption, and saving in some country are $200 billion, $150 billion, and $50 billion, respectively. Next, assume that disposable income increases by $20 billion, consumption rises by $18 billion and saving goes up by $2 billion. What is the economy’s MPC? Its MPS? What was the APC before the increase in disposable income? After the increase?

3. Advanced Analysis Suppose that the linear equation for consumption in a hypothetical economy is C = 40 + .8Y. Also suppose that income (Y) is $400. Determine (a) the marginal propensity to consume, (b) the marginal propensity to save, (c) the level of consumption, (d) the average propensity to consume, (e) the level of saving, and (f) the average propensity to save.

4. Advanced Analysis Linear equations for the consumption and saving schedules take the general form C = a + bY and S= -a + (1-b)Y where C, S, and Y are consumption, saving, and national income, respectively. The constant a represents the vertical intercept, and b represents the slope of the consumption schedule. LO1, LO2

a. Use the following data to substitute numerical values for a and b in the consumption and saving equations.

b. What is the economic meaning of b? Of (1 - b)?

c. Suppose that the amount of saving that occurs at each level of national income falls by $20 but that the values of b and (1 - b) remain unchanged. Restate the saving and consumption equations inserting the new numerical values, and cite a factor that might have caused the change.

5. Use your completed table for problem 1 to solve this problem. Suppose the wealth effect is such that $10 changes in wealth produce $1 changes in consumption at each level of income. If real estate prices tumble such that wealth declines by $80, what will be the new level of consumption at the $340 billion level of disposable income? The new level of saving? LO2

6. Suppose a handbill publisher can buy a new duplicating machine for $500 and the duplicator has a 1-year life. The machine is expected to contribute $550 to the year’s net revenue. What is the expected rate of return? If the real interest rate at which funds can be borrowed to purchase the machine is 8 percent, will the publisher choose to invest in the machine? Will it invest in the machine if the real interest rate is 9 percent? If it is 11 percent? LO3

7. Assume there are no investment projects in the economy that yield an expected rate of return of 25 percent or more. But suppose there are $10 billion of investment projects yielding expected returns of between 20 and 25 percent; another $10 billion yielding between 15 and 20 percent; another $10 billion between 10 and 15 percent; and so forth. Cumulate these data and present them graphically, putting the expected rate of return (and the real interest rate) on the vertical axis and the amount of investment on the horizontal axis. What will be the equilibrium level of aggregate investment if the real interest rate is (a) 15 percent, (b) 10 percent, and (c) 5 percent? LO3

8. Refer to the table in Figure 27.5 in the book and suppose that the real interest rate is 6 percent. Next, assume that some factor changes such that that the expected rate of return declines by 2 percentage points at each prospective level of investment. Assuming no change in the real interest rate, by how much and in what direction will investment change? Which of the following might cause this change: (a) a decision to increase inventories; (b) an increase in excess production capacity? LO4

9. What will the multiplier be when the MPS is 0, .4, .6, and 1? What will it be when the MPC is 1, .90, .67, .50, and 0? How much of a change in GDP will result if firms increase their level of investment by $8 billion and the MPC is .80? If the MPC instead is .67? LO5

10. Suppose that an initial $10 billion increase in investment spending expands GDP by $10 billion in the first round of the multiplier process. If GDP and consumption both rise by $6 billion in the second round of the process, what is the MPC in this economy? What is the size of the multiplier? If, instead, GDP and consumption both rose by $8 billion in the second round, what would have been the size of the multiplier? LO5

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