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## 22 Sep What is an investment schedule and how does it differ from an investment demand curve?

Chapter 28 The Aggregate Expenditures Model QUESTIONS

1.            What is an investment schedule and how does it differ from an investment demand curve?

2.            Assuming the level of investment is \$16 billion and independent of the level of total output, complete the accompanying table and determine the equilibrium levels of output and employment in this private closed economy. What are the sizes of the MPC and MPS?

3.            Using the consumption and saving data in problem 1 and assuming investment is \$16 billion, what are saving and planned investment at the \$380 billion level of domestic output? What are saving and actual investment at that level? What are saving and planned investment at the \$300 billion level of domestic output? What are the levels of saving and actual investment? In which direction and by what amount will unplanned investment change as the economy moves from the \$380 billion level of GDP to the equilibrium level of real GDP? From the \$300 billion level of real GDP to the equilibrium level of GDP?

4.            Why is saving called a leakage? Why is planned investment called an injection? Why must saving equal planned investment at equilibrium GDP in the private closed economy? Are unplanned changes in inventories rising, falling, or constant at equilibrium GDP? Explain.

5.            Depict graphically the aggregate expenditures model for a private closed economy. Now show a decrease in the aggregate expenditures schedule and explain why the decline in real GDP in your diagram is greater than the initial decline in ag- gregate expenditures. What would be the ratio of a decline in real GDP to the initial drop in aggregate expenditures if the slope of your aggregate expenditures schedule was .8?

6.            By how much will GDP change if firms increase their investment by \$8 billion and the MPC is .80? If the MPC is .67?

7.            Suppose that a certain country has an MPC of .9 and a real GDP of \$400 billion. If its investment spending decreases by \$4 billion, what will be its new level of real GDP?

8.            The data in columns 1 and 2 in the accompanying table are for a private closed economy:

a.            Use columns 1 and 2 to determine the equilibrium GDP for this hypothetical economy. Equilibrium for this economy occurs where Aggregate Expenditures for the Private Closed Economy equals Real Gross Domestic Product. Thus, equilibrium is \$400 billion.

b.            Now open up this economy to international trade by including the export and import figures of columns 3 and 4. Fill in columns 5 and 6 and determine the equilibrium GDP for the open economy. What is the change in equilibrium GDP caused by the addition of net exports?

c.             Given the original \$20 billion level of exports, what would be net exports and the equilibrium GDP if imports were \$10 billion greater at each level of GDP?

d.            What is the multiplier in this example?

9.            Assume that, without taxes, the consumption schedule of an economy is as follows

a.            Graph this consumption schedule and determine the MPC.

b.            Assume now that a lump-sum tax is imposed such that the government collects \$10 billion in taxes at all levels of GDP. Graph the resulting consumption schedule and compare the MPC and the multiplier with those of the pretax consumption schedule.

10.          Explain graphically the determination of equilibrium GDP for a private economy through the aggregate expenditures model. Now add government purchases (any amount you choose) to your graph, showing its impact on equilibrium GDP. Finally, add taxation (any amount of lump sum tax that you choose) to your graph and show its effect on equilibrium GDP. Looking at your graph, determine whether equilibrium GDP has increased, decreased, or stayed the same given the sizes of the government purchases and taxes that you selected

11 Refer to columns 1 and 6 of the tabular data for question 9. Incorporate government into the table by assuming that it plans to tax and spend \$20 billion at each possible level of GDP. Also assume that all taxes are personal taxes and that government spending does not induce a shift in the private aggregate expenditures schedule. Compute and explain the changes in equilibrium GDP caused by the addition of government.

12.          Refer to the accompanying table in answering the questions that follow: LO5

a.            If full employment in this economy is 130 million, will there be an inflationary expenditure gap or a recessionary expenditure gap? What will be the consequence of this gap? By how much would aggregate expenditures in column 3 have to change at each level of GDP to eliminate the inflationary expenditure gap or the recessionary expenditure gap? What is the multiplier in this example?

b.            Will there be an inflationary expenditure gap or a recessionary expenditure gap if the full-employment level of output is \$500 billion? By how much would aggregate expenditures in column 3 have to change at each level of GDP to eliminate the gap? What is the multiplier in this example?

c.             Assuming that investment, net exports, and government expenditures do not change with changes in real GDP, what are the sizes of the MPC, the MPS, and the multiplier? To find the marginal propensity to consume (MPC) divide the change in aggregate expenditures by the change in real domestic output (assuming that investment, net exports, and government expenditures do not change with changes in real GDP).

13.          Assume that the consumption schedule for a private open economy is such that consumption C = 50 + 0.8Y. Assume further that planned investment Ig and net exports Xn are independent of the level of real GDP and constant at Ig = 30 and Xn = 10. Recall also that, in equilibrium, the real output produced (Y) is equal to aggregate expenditures: Y = C +Ig + Xn. LO4

a.            Calculate the equilibrium level of income or real GDP for this economy.

b.            What happens to equilibrium Y if Ig changes to 10? What does this outcome reveal about the size of the multiplier?

a.            Calculate the equilibrium level of income or real GDP for this economy. In equilibrium we have the following relationship:

b.            What happens to equilibrium Y if Ig changes to 10? What does this outcome reveal about the size of the multiplier?

14.          Answer the following questions, which relate to the aggregate expenditures model: LO5

a.            If C is \$100, Ig is \$50, Xn is –\$10, and G is \$30, what is the economy’s equilibrium GDP?

b.            If real GDP in an economy is currently \$200, C is \$100, Ig is \$50, Xn is -\$10, and G is \$30, will the economy’s real GDP rise, fall, or stay the same?

c.             Suppose that full-employment (and full-capacity) output in an economy is \$200. If C is

\$150,

Ig is \$50, Xn is –\$10, and G is \$30, what will be the macroeconomic result?

a.            If C is \$100, Ig is \$50, Xn is –\$10, and G is \$30, what is the economy’s equilibrium GDP?

b.            If real GDP in an economy is currently \$200, C is \$100, Ig is \$50, Xn is -\$10, and G is \$30, will the economy’s real GDP rise, fall, or stay the same?

c.             Suppose that full-employment (and full-capacity) output in an economy is \$200. If C is\$150, Ig is \$50, Xn is –\$10, and G is \$30, what will be the macroeconomic result?

15.          What is Say’s law? How does it relate to the view held by classical economists that the economy generally will operate at a position on its production possibilities curve

Use production possibilities analysis to demonstrate Keynes’ view on this matter.

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