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Intermediate Macroeconomics Exam II Questions and Answers
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Intermediate Macroeconomics Exam II Questions and Answers Model of aggregate demand and aggregate supply - ANSWER-Long run: prices flexible, output determined by factors of production & technology, unemployment equals its natural rate Short run: prices fixed, output determined by aggregate dema...

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  • November 11, 2024
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Intermediate Macroeconomics Exam II

Questions and Answers


Model of aggregate demand and aggregate supply - ANSWER✔✔-Long run: prices flexible, output

determined by factors of production & technology, unemployment equals its natural rate


Short run: prices fixed, output determined by aggregate demand, unemployment negatively related to

output


The Keynesian cross - ANSWER✔✔-Closed economy model; income determined by expenditure.


I = planned investment


PE = C + I + G = planned expenditure


Y = real GDP = actual expenditure


Difference between actual & planned expenditure = unplanned inventory investment


Consumption function - ANSWER✔✔-C = C(Y - T)


Government policy variables - ANSWER✔✔-G = G[bar], T = T[bar]


Investment - ANSWER✔✔-I = I[bar] -> exogenous


Planned expenditure - ANSWER✔✔-PE = C(Y-T) + I[bar] + G[bar]


Slope of PE line = MPC




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I and G are exogenous, so the only component of (C + I + G) that changes when income changes is

consumption. A one-unit increase in income causes consumption & therefore the PE to increase by the

MPC.


Equilibrium condition for the Keynesian cross - ANSWER✔✔-Actual expenditure = planned expenditure


Y = PE


Graphing the equilibrium condition for the Keynesian cross - ANSWER✔✔-PE on vertical axis


Y on horizontal axis


45 degree line


An increase in government purchases and the Keynesian cross - ANSWER✔✔-At Y1, an unplanned drop

in inventory causes firms to increase output, and income rises toward a new equilibrium


At any value of Y, an increase in G by the amount deltaG causes an increase in PE by the same amount. At

Y1, there is an unplanned depletion of inventories because people are buying more than firms are

producing (PE > Y)


Solving for delta Y - ANSWER✔✔-Y = C + I + G


delta Y = delta C + delta I + delta G


= delta C + delta G


= MPC x delta Y + delta G (because delta C = MPC x deltaY)


(1 - MPC) x delta Y = delta G. Solve for Y:


delta Y = (1/(1-MPC)) x delta G




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Government purchases multiplier - ANSWER✔✔-The increase in income resulting from a $1 increase in

G.


In this model, delta Y/delta G = (1-(1/MPC)


Example: If MPC = 0.8, then


delta Y / delta G = (1/(1-0.8)) = 5


An increase in G causes income to increase by 5 times as much


Why the government purchases multiplier is greater than 1 - ANSWER✔✔-Initially, the increase in G

causes an equal increase in Y; that is, delta G = delta Y. But an increase in Y -> an increase in C, which

further increases Y, which further increases C, etc. So the final impact on income is much bigger than the

initial delta G.


An increase in taxes - ANSWER✔✔-Initially, tax increases reduce consumption (by a measure of MPC x

delta T) and therefore PE (does not affect I and G, as they are exogenous). So firms reduce output, and

income falls toward a new equilibrium. At Y1, there is now an unplanned inventory buildup.


See book for an example about a decrease in taxes


Solving for delta Y with an increase in taxes - ANSWER✔✔-delta Y = (-MPC/(1-MPC)) x delta T


Tax multiplier - ANSWER✔✔-The change in income resulting from a $1 increase in T


delta Y/delta T = (-MPC/(1-MPC))


If MPC = 0.8, tax multiplier is: delta Y/delta T = (-0.8/(1-0.8)) = (-0.8/0.2) = -4




-The tax multiplier is negative because a tax increase reduces C, which reduces income.

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