CHAPTER 9 / 11 APPENDICES

OPEN ECONOMY MACROECONOMICS

Chapter 9 Appendix A

TEST YOURSELF

2.   Y = C + I + G + (X – IM)

C = 250 + 0.5DI

C = 250 + 0.5(Y – 400)

C = 250 + 0.5Y – 200

C= 50 + 0.5Y

Y = 50 + 0:5Y + 250 + 400 + 0

Y = 0.5Y + 700

0.5Y= 700

Y = (1/0.5) ´ 700

Y = 2 ´ 700 = 1400

DISCUSSION QUESTIONS

1.   The multiplier works through consumer spending and disposable income.  When autonomous spending in the economy rises, this increases income paid to the factors of production, such as labor. When labor receives more income, disposable income rises, and therefore, consumption rises. This fuels more spending and income payments. Since people consume only a fraction of each additional dollar earned, the multiplier process eventually stops when the economy reaches its new equilibrium.

In order for the multiplier process to work, the marginal propensity to consume must be greater than 0 and less than 1. If it were equal to zero, then workers would not increase consumer spending when income rises, so there would be no multiplier effect. If the marginal propensity to consume were greater than 1, then the multiplier effects would never stop and the economy would never reach an equilibrium where expenditures equal income.

 

Chapter 9 Appendix B

TEST YOURSELF

2.   In Figure 4, the intersection of the lower expenditure line with the 45-degree line shows an equilibrium GDP of 4,000.

            Figure 4

 

Chapter 11 Appendix A

TEST YOURSELF

2.   To answer this question, consider the two policies independently, then combine them to compute the net effects.

            $100 billion increase government spending effect on equilibrium GDP = 2 x $100 billion = $200 billion

          $100 billion increase fixed taxes effect on equilibrium GDP = -1.5 x $100 billion =       -$150 billion

          Therefore, the net effect of these two policies is to raise equilibrium GDP by $50 billion (= $200 billion – $150 billion).

 DISCUSSION QUESTIONS

1.   The multiplier increases with the decrease in income taxes.  Higher income taxes reduce the size of the multiplier.   With lower income taxes, changes in spending will have a larger effect on consumer disposable income, leading to larger changes in consumption, causing larger multiplier effects.

2.   The multiplier measures how changes in autonomous spending affect equilibrium GDP.  A lower multiplier means that when there are shocks to spending, the overall effects on GDP will be smaller.  This can be a good thing if we consider shocks that have a negative effect on real GDP, such as lower business confidence.  However, a lower multiplier may be a bad thing if we consider the ability of fiscal policy to boost the economy during a recession.  With a lower multiplier, expansionary fiscal policy has a smaller effect on equilibrium GDP, meaning that the government would have to raise government spending dramatically or severely cut taxes to close a recessionary gap.

A higher multiplier means that shocks have larger effects on equilibrium GDP. For example, if there is greater business confidence or increases in government spending, then equilibrium GDP will change by a large amount.  There are drawbacks however, if the economy suffers from a negative shock, such as lower consumer confidence or lower exports, then the effects on GDP will be more dramatic.

 

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