Key Concepts
Discussion and Review Questions
Learning Objective A.1 Measure aggregate expenditure and analyze how it varies with income.
Explain why unplanned inventory changes are not considered part of aggregate expenditure.
You receive $1,000. How much of it will you spend this year and how much of it will you save? What is your marginal propensity to consume?
Learning Objective A.2 Find the macroeconomic equilibrium and analyze how it changes as economic conditions change.
Spending depends on income, income depends on production, and production depends on spending. Explain how this circular interdependence is resolved at the macroeconomic equilibrium.
Explain why the 45-degree line represent all the possible points of macroeconomic equilibrium. Why would production tend to change if it is to the left or right of the 45-degree line?
Use the Keynesian cross to illustrate how changes in aggregate expenditure can lead to changes in output. Provide an example of something that would lead to a recession and something that would lead to an expansion. Illustrate each example with a small graph showing the shift in aggregate expenditure and the subsequent change in output.
Learning Objective A.3 Analyze how moderate changes in spending can have bigger consequences through the multiplier effect.
If everyone has the same marginal propensity to consume as you indicated in your answer to question 2, determine the multiplier. Explain why the marginal propensity to consume determines the multiplier.
Your state legislators and governor are debating whether they should use state funds to encourage motion picture studios to shoot and produce films in your state. The governor’s office issues a report that includes the following statement:
“The average budget for a movie is $70 million but our consultants estimate that this will have broader ripple effects across many industries and will boost state output by about $210 million dollars.”
What multiplier is the governor’s office using to come to this conclusion? Do you think the multiplier is realistic for this scenario?
Study Problems
Learning Objective A.1 Measure aggregate expenditure and analyze how it varies with income.
In 2018, Real GDP in the United States increased by $516 billion and consumption spending increased by $329 billion.
What do these data suggest was the marginal propensity to consume?
If real income increases by $250 billion in 2019, use this estimate of the marginal propensity to consume to predict how consumption spending will change in 2019.
Use the graph to answer the following questions.
What is consumption spending if income is $15 trillion?
What is aggregate expenditure if income is $15 trillion?
What is the sum of planned investment, government purchases, and net exports when income is $15 trillion?
If income rises, will consumption rise, fall, or stay the same? Will this cause the consumption function to shift? Explain your reasoning.
If income falls, will aggregate expenditure rise, fall, or stay the same? Will this cause the aggregate expenditure line to shift? Explain your reasoning.
Learning Objective A.2 Find the macroeconomic equilibrium and analyze how it changes as economic conditions change.
If aggregate expenditure in Thailand this year is on track to be $500 billion and output is $400 billion, is the economy currently at a macroeconomic equilibrium? Predict how unplanned inventories will change. How will producers respond to this imbalance? Do you anticipate GDP will rise or fall in response?
Draw an aggregate expenditure graph and label the macroeconomic equilibrium on it occurring when real GDP is $7 trillion. Then illustrate how a decrease in aggregate expenditure will lead the economy to experience a recession as it shifts to a new macroeconomic equilibrium where real GDP is $5 trillion.
Forecast how aggregate expenditure and real GDP will change in each of the following scenarios. Indicate which component of aggregate expenditure changes and illustrate your answers with a graph.
A sharp uptick in stock prices increases consumer wealth and makes consumers willing to spend more at each level of income.
The EU imposes tariffs on all goods imported from the United States, which causes U.S. exports to fall.
Congress passes a new tax law that removes a business investment tax credit. In response to this change, businesses spend $500 billion less on new machinery and building projects.
Congress passes a fiscal stimulus package that devotes $400 billion to improving infrastructure across the country.
Bolstered by reassurances from the Fed, businesses become confident that historically low interest rates will continue for the foreseeable future and begin to plan large investment projects.
Learning Objective A.3 Analyze how moderate changes in spending can have bigger consequences through the multiplier effect.
In response to a $240 billion increase in government purchases, GDP increased by $360 billion.
What is the multiplier?
Use this estimate to predict how GDP will change if businesses invest an additional $100 billion in capital investment projects.
What is the marginal propensity to consume?
The federal government is expected to pass a new spending bill that increases government purchases by $50 billion. Predict how GDP will change if the multiplier is 1.2. Explain why the change in GDP is not exactly equal to the change in government spending.