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Solution

The following table illustrates the completed table. The equilibrium is level is italicized.

National Income After-tax Income Consumption I + G + X Minus Imports Aggregate Expenditures
$8,000 $4,800 $4,340 $5,000 $240 $9,100
$9,000 $5,400 $4,820 $5,000 $270 $9,550
$10,000 $6,000 $5,300 $5,000 $300 $10,000
$11,000 $6,600 $5,780 $5,000 $330 $10,450
$12,000 $7,200 $6,260 $5,000 $360 $10,900
$13,000 $7,800 $46,740 $5,000 $4,390 $11,350

The alternative way of determining equilibrium is to solve for Y, where Y = national income, using: Y = AE = C + I + G + X – M

Y = $500 + 0.8(Y – T) + $2,000 + $1,000 + $2,000 – 0.05(Y – T)

Solving for Y, we see that the equilibrium level of output is Y = $10,000.

Explain how the multiplier works. Use an MPC of 80% in an example.

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Solution

The multiplier refers to how many times a dollar will turnover in the economy. It is based on the Marginal Propensity to Consume (MPC) which tells how much of every dollar received will be spent. If the MPC is 80% then this means that out of every one dollar received by a consumer, $0.80 will be spent. This $0.80 is received by another person. In turn, 80% of the $0.80 received, or $0.64, will be spent, and so on. The impact of the multiplier is diluted when the effect of taxes and expenditure on imports is considered. To derive the multiplier, take the 1/1 – F; where F is equal to percent of savings, taxes, and expenditures on imports.

Review questions

What is on the axes of an expenditure-output diagram?

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What does the 45-degree line show?

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What determines the slope of a consumption function?

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What is the marginal propensity to consume, and how is it related to the marginal propensity to import?

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Why are the investment function, the government spending function, and the export function all drawn as flat lines?

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Why does the import function slope down? What is the marginal propensity to import?

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What are the components on which the aggregate expenditure function is based?

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Is the equilibrium in a Keynesian cross diagram usually expected to be at or near potential GDP?

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What is an inflationary gap? A recessionary gap?

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What is the multiplier effect?

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Why are savings, taxes, and imports referred to as “leakages” in calculating the multiplier effect?

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Will an economy with a high multiplier be more stable or less stable than an economy with a low multiplier in response to changes in the economy or in government policy?

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How do economists use the multiplier?

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Critical thinking questions

What does it mean when the aggregate expenditure line crosses the 45-degree line? In other words, how would you explain the intersection in words?

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Which model, the AD/AS or the AE model better explains the relationship between rising price levels and GDP? Why?

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What are some reasons that the economy might be in a recession, and what is the appropriate government action to alleviate the recession?

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What should the government do to relieve inflationary pressures if the aggregate expenditure is greater than potential GDP?

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Two countries are in a recession. Country A has an MPC of 0.8 and Country B has an MPC of 0.6. In which country will government spending have the greatest impact?

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Compare two policies: a tax cut on income or an increase in government spending on roads and bridges. What are both the short-term and long-term impacts of such policies on the economy?

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What role does government play in stabilizing the economy and what are the tradeoffs that must be considered?

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If there is a recessionary gap of $100 billion, should the government increase spending by $100 billion to close the gap? Why? Why not?

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What other changes in the economy can be evaluated by using the multiplier?

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References

Joyner, James. Outside the Beltway. “Public Financing of Private Sports Stadiums.” Last modified May 23, 2012. http://www.outsidethebeltway.com/public-financing-of-private-sports-stadiums/.

Siegfried, John J., and Andrew Zimbalist. “The Economics of Sports Facilities and Their Communities.” Journal of Economic Perspectives . no. 3 (2000): 95-114. http://pubs.aeaweb.org/doi/pdfplus/10.1257/jep.14.3.95.

Questions & Answers

account for persistent increase in lnflation
niwahereza Reply
what is opportunity cost
Adebowale Reply
government measures to control inflation?
Formu Reply
how do we calculate the firm's profit maximizing output in the short run given marginal cost ,average cost and average variable costs?
Nomuhle Reply
what is employment?
Ahmarh Reply
what is meant by broadening the tax base?
Fiona Reply
What is scarcity.
Npoanlarb Reply
when there is adequate resources
Fiona
the represent inadequacy of resources relative to the needs of individuals
Moses
scarcity is the unavailability of resources to attain unlimited wants and needs of people
Nzubechukwu
for exam land and money
Ruchi
hi negi
Gul
Scarcity in economics means resources are limited supply or insufficient to satisfy all human wants.
Addai
why our wants are limited
Npoanlarb Reply
nooo want is unlimited but resources are limited
Ruchi
and do to that there occurs scarcity and we have to make choice in order to have what we need if need be I will explain more
Madara
our wants are not limited but rather the resources
Moses
as we know that there are two principle of microeconomics scarcity of resources and they have alternative uses...
Ruchi
yes .....
Mathias
because our resources are limited./we have a limited resources.
Ijeoma
our wants are not limited. because always the desire for something always arises. our means are rather limited and our wants are unlimited
Anthony
because always the desire for...
Addai
what is demand
Thank Reply
demand is something wt we called in economic theory of demand it simply means if price of product is increase then demand of product will decrease
Ruchi
inverse relationship between demand and price
Ruchi
in microeconomic
Ruchi
demand is what and how much you want and what's your need...
Shikhar
desire is what and how much you want and what's your need..
Addai
willingness or mobility of consumer to purchase quantity of good or services
Smriti
obility
Smriti
how can one be so with economics even while you have less knowledge in mathematics.
OKORO Reply
why is it that some products increases everyday by day
Chiamaka Reply
because demand is increase
Ruchi
because demand is increase
Patience
but how demand increases?
Aziz
Because of the Marketing and purchasing power of people.
AmarbirSingh
but how could we know that people's demands have increased everyday by day and how could we know that this is time to produced the products in the market. Is any connection among them
yaqoob
for normal good people demand remain the same if price of product will increase or not
Ruchi
see that some product which increases day by day is comes under normal good which is used by consumer
Ruchi
Seems hot discussing going here
Shamamet
If there are less products demand starts to increase for those products
Shamamet
Economics is really interesting to learn ....
Shamamet
see there is Inferior goods ands normal goods inferior good demand is rarely increase whereas as we talk about normal good demand will absolutely Increase whether price is increase or not
Ruchi
and demand for normal goods increase cause people's income as a while increases time to time
Abhisek
and it might also be that the cost of raw materials are high.
ATTAH
may be
Ruchi
obviously because demand is increasing.....and price is getting low.....
Shikhar
hmmm there is inverse relationship between demand and price
Ruchi
This is because the supply of those products in relation to raw materials are decreasing and they are also necessities. This crate shortage in the market, so sellers will rise the prices of those products.
Abdul
increase in price of product is as a result of increase in supply... according to law of supply
Nzubechukwu
Importance of economics
Odunayomi Reply
the nature and significance of economics studies
Deborah
What is demand
Shuaib Reply
deman is amount of goods and services a consumer is willing and able to buy or purchase at a given price.
Sainabou
the willingness and ability of a body to purchase goods nd servicesbis called demand ,so if she/has ability but doesn't have willingness it's not a demand same if she or he has willingness but doesn't has ability it's not a demand too
Gul
Demand refers to as quantities of a goods and services in which consumers are willing and able to purchase at a given period of time and demand can also be defined as the desire or willingness and backed by the ability to pay.
Fadiga
Yeah
Mathias
What is Choice
Kofi
Choice refers to the ability of a consumer or producer to decide which good, service or resource to purchase or provide from a range of possible options. Being free to chose is regarded as a fundamental indicator of economic well being and development.
Shonal
choice is a act of selecting or choosing from the numerous or plenty wants.
Fadiga
demand is want and it is also what you need and able to afford a particular period of time... because demand changes with time.
Ijeoma
Demand refers to the ability of the consumer to pay for a particular product at a given price
Abdul
this is the desire or willingness to purchase goods and services backed up with the ability to pày
Nzubechukwu
how does consumer make profit
Clifford Reply
by buying goods in bulk.
Ijeoma
Compare and contract the function of commercial bank and the central bank of Nigeria
Akwi Reply
what do think is the difference between overhead costs and prime cost
Abdoulkarim

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Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
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