Answers to Assignment Six
1.Use the graph below to explain the determination of equilibrium GDP by the aggregate
expenditures-domestic output approach. At equilibrium C + Ig = Real GDP ($550 + $50
= $600). Why does the intersection of the aggregate expenditures schedule and the 45-
degree line determine the equilibrium GDP?
Equilibrium occurs where C + Ig = GDP. There is a direct relationship between
aggregate expenditures and the level of GDP, but they are equal only where the AE
schedule intersects the 45-degree line which shows equality of expenditures and GDP.
Where aggregate expenditures exceed GDP, the AE line is above the 45-degree line and
output will continue to expand. If aggregate expenditures fall below GDP as would
occur at levels above 600, then GDP will contract until the expenditures-output equality
is restored.
The 45-degree line in the aggregate expenditures model represents all of the points
where aggregate expenditures are equal to real GDP; all of the possible equilibrium
levels.
2.What differentiates the planned equilibrium level of investment from disequilibrium levels
of investment? Explain.
Planned investment differs from unplanned investment by the changes in inventories. If
inventories exceed the planned level, then producers will want to reduce output. If
inventories are less than the planned level, then producers will want to expand output.
Only when inventories are at the planned level will there be an equilibrium level of GDP.
3.The data in the first two columns below are for a closed economy. Use this table to answer
the following questions.
Real GDP Aggregate Net Aggregate
= DI expenditures Exports Imports exports expenditures
(billions) (billions) (billions) (billions) (billions) (billions)
$100 $120 $10 $15 $___ $___
125 140 10 15 ___ ___
150 160 10 15 ___ ___
175 180 10 15 ___ ___
200 200 10 15 ___ ___
225 220 10 15 ___ ___
250 240 10 15 ___ ___
275 260 10 15 ___ ___
(a)What is the equilibrium GDP for the closed economy?
(b) Including the international trade figures for exports and imports, calculate net
exports and determine the equilibrium GDP for an open economy.
(c)What will happen to equilibrium GDP if exports were $5 billion larger at each level
of GDP?
(d) What will happen to equilibrium GDP if exports remained at $10 billion, but
imports dropped to $5 billion?
(e)What is the size of the multiplier in this economy?
Real GDP Aggregate Net Aggregate
= DI expenditures Exports Imports exports expenditures
(billions) (billions) (billions) (billions) (billions) (billions)
$100 $120 $10 $15 $–5 $115
125 140 10 15 –5 135
150 160 10 15 –5 155
175 180 10 15 –5 175
200 200 10 15 –5 195
225 220 10 15 –5 215
250 240 10 15 –5 235
275 260 10 15 –5 255
(a)For a closed economy, equilibrium GDP = $200 billion.
(b) For an open economy, equilibrium GDP = $175 billion.
(c)Equilibrium GDP would return to $200 billion.
(d) Equilibrium GDP would rise to $225 billion.
(e)When aggregate expenditures change by 5, equilibrium GDP changes by 25 so the
multiplier must be 5.
4.“If taxes and government spending are increased by the same amount, there will still be a
positive effect on equilibrium GDP.” Explain.
The initial impact of government spending is to increase aggregate demand directly
by the amount of the increase in spending. Beyond that, spending is increased in
successive rounds of increased incomes that result by a fraction equal to the marginal
propensity to consume. This MPC-induced spending which results from the increased
government purchases will be exactly offset by the tax increase whose initial impact is to
reduce disposable income rather than aggregate demand directly. Thus, government
spending has an initial direct effect equal to the amount of the increase in G which will
not be offset.
5.Suppose that the linear equation for consumption in a hypothetical economy is C = 50 + 0.9
Y. Also suppose that income (Y) is $400. Determine the following: (a) MPC; (b) MPS;
(c) level of consumption; (d) APC; (e) APS.
MPC = 0.9; MPS = 0.1; At Y = 400, C = $410; At Y = $400, APC = 410/400 = 1.025;
and APS = (–.025).
6.Assume the consumption schedule for the economy is such that C = 50 + 0.8Y. Assume
further that investment and net exports are autonomous or independent of the level of
income and gross investment is 40 and net exports equal –10. Recall that in equilibrium,
Y = C + Ig + Xn.
(a)Calculate the equilibrium level of income for this economy.
(b)What will happen to equilibrium Y if gross investment falls to 20? What does
this tell us about the size of the multiplier?
(a) Equilibrium GDP is 400 = (50 = 0.8Y) + 40 + (–10)
(b) If gross investment falls by 20, GDP will fall by 100 because the multiplier is 1/.2 or
5 and 5 20 = 100 decline. The new equilibrium would be 300.
