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Trisem 252022-23 BMT6111 TH VL2022230300008 Reference Material I 12-11-2022 MPC MPS 3
Mathematics
Sikkim Manipal University
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Unit 3 Exam Review
Income and Expenditure 1. Figure MPC and MPS. See formulas and practice question #23 below. 2. Explain relationship between MPC and the multiplier. Direct relationship, the higher the MPC, the greater the multiplier. 3. List and understand reasons for shifts in consumption graph. 1) Change in expectations about future disposable income, 2) change in aggregate wealth 4. Figure the multiplier and the resulting impact of autonomous changes in spending. See formulas and practice questions #24 and 25 below. 5. Figure and graph the consumption function. How is MPC represented on the graph? See formulas and practice question #26 below.
Aggregate Supply & Aggregate Demand
- Define aggregate supply and aggregate demand. Aggregate supply – The total amount of goods and services that all firms in a country are willing to produce at each price level. Aggregate demand – The total quantity of all goods and services demanded at each price level.
- List and understand reasons for shifts of the AS and AD curves.
AD: 1) Change in Expectations, 2) Change in Wealth, 3) Size of Inventory, 4) Fiscal Policy, 5) Monetary Policy SRAS: 1) Change in Commodity (input) prices, 2) change in nominal wages, 4) change in productivity LRAS: 1) Increase in quantity of resources, 2) increases in quality of resources, 3) improvements in technology 8. Identify results of AD and AS shifts on: See practice question # a. Employment/unemployment Negative AD or AS shift results in lower employment, positive AD or AS shift results in higher employment b. Price level Negative AD shift results in lower price level, positive AD shift results in higher price level Negative AS shift results in higher price level, positive AS shift results in lower price level c. Real GDP Negative AD or AS shift results in lower Real GDP, positive AD or AS shift results in higher Real GDP 9. Explain why the AD curve is downward sloping. 1)Interest rate effect, 2) Wealth effect, 3) Net Export effect 10. Explain why the SRAS and LRAS curves are sloped as they are. SRAS: Wages are “sticky”, LRAS: Wages are fully flexible 11. Define sticky wages and relationship with aggregate supply. (noted above)
The AD-AS Model 12. Determine the impact of market conditions on SRAS, LRAS and the PPC. See #7 above and practice question #39. 13. Define and understand potential output’s (YP) relationship with the AD-AS Model. Level of production if prices are fully flexible (LRAS) 14. Identify and graph inflationary and recessionary gaps. Recessionary Gap Inflationary gap
- Define stagflation and identify its effects on the economy. See practice question #33. Stagflation – rising prices and falling output (as well as rising unemployment). Result from leftward shift of SRAS curve (reduction in supply). Difficult to deal through policy because any attempt to deal with either inflation or unemployment worsens the other issue.
Long-Run Macroeconomic Equilibrium & Government Policy 16. Explain the differences between automatic and discretionary stabilization.
Formulas to Know:
MPC = ∆Consumption/∆Yd
MPS = ∆Savings/∆Yd
Consumer/government spending
multiplier = 1/1-MPC
Tax Multiplier= --MPC/1-MPC
Consumption function =
A + (MPC x Yd)
Automatic stabilizers are things that are already in place that reduce the severity of a recession or the excesses of an expansion. Discretionary fiscal policies are specific policy actions taken by the government in response to an inflationary or recessionary gap. 17. Give examples of automatic stabilizers. Examples are progressive income taxes and government transfers (social welfare programs) that increase as a result of need. 18. Compare multiplier effects of fiscal policy options. See practice question #38 below. Government spending has a direct effect on the economy, so its total impact on Real GDP is multiplied times the spending multiplier (1/(MPC)). Changes in taxes or transfers has an indirect effect, as it puts the money in the hands of consumers – who then choose whether to spend or save. For this reason, the initial autonomous change in spending is reduced (as the initial inflow of money is already multiplied by the spending multiplier). The initial autonomous change is MPC/(1-MPC) instead. Therefore, the total impact on Real GDP is reduced. 19. Evaluate fiscal policy options to combat recessions and inflation. (Which government actions are likely to be most effective?) See #18 above and practice question #39 below. 20. List examples of government transfers. Social Security, Medicare, Medicaid, VA benefits, Unemployment compensation 21. Explain the difference in multiplier effects between the spending and tax multiplier. Spending Multiplier: the ratio of total change in Real GDP to the size of autonomous change in spending (the cause of the chain reaction) Taxes on disposable income reduce the size of the spending multiplier 22. Explain why MPC + MPS + taxes = 1. The portion of each dollar that goes to the government in the form of taxes is no longer available for spending or savings.
Practice Questions 23. Complete this chart. Income Expenditures MPC MPS $0 $8,000 N/A N/A $20,000 $11,000 0 0. $40,000 $25,000 0 0. $60,000 $35,000 0 0. $80,000 $41,000 0 0. What is the autonomous consumer spending? $8,
- Determine the multiplier and the net effect of the following autonomous changes in spending: a. An influx of $100 billion in government spending when the marginal propensity to consume is 0. Multiplier = 1/1-MPC or 1/1- = 1/ = 4 Net effect of $100 billion spending is $100 billion 4 = $400 billion
b. An influx of $250 billion in business investment when the marginal propensity to consume is 0. Multiplier = 1/1-MPC or 1/1- = 1/ = 2 Net effect of $250 billion spending is $250 billion 2 = $500 billion c. An influx of $180 billion in export sales revenue when the marginal propensity to consume is 0. Multiplier = 1/1-MPC or 1/1- = 1/ = 5 Net effect of $180 billion spending is $180 billion 5 = $900 billion 25. If consumer spending increased by $25 billion, resulting as an equilibrium output increasing by $75 billion. What is the value of the MPC? K=3 ($75 billion/$25 billion), 3=1/MPS, MPS=, MPC=. 26. Suppose an individual’s autonomous consumption is $15,000, his disposable income is $50,000 and his marginal propensity to consume is .75. What is the individual’s consumption spending? CF= $15,000 + ($50,000 x .75), CF = $52, 27. Falling inventories, also known as Negative Unplanned Inventory Investment_, occurs when sales are (higher/lower) than expected. This reflects a (strengthening/weakening) economy.
- Rising inventories, also known as Positive Unplanned Inventory Investment, occurs when sales are (higher/lower) than expected. This reflects a (strengthening/weakening) economy.
- How would each of the following impact the level of planned investment spending?
Effect on investment spending Effect on investment spending Interest rates High ↓ Low ↑ Expected real GDP High ↑ Low ↓ Production capacity High ↑ Low ↓
A change in Price Level results in movement along the AD/AS curves.
Potential Output is equal to $500 billion and current output is $400 billion. What is the output gap? ($400-$500)/$500 x 100 = -20%
Complete the following chart of discretionary policy options.
Policy Fiscal/ Monetary?
Expansionary/ Contractionary?
Implement for Recessionary/ Inflationary Gap?
Effect on inflation (price level)
Effect on unemployment
Increasing taxes F C Inflationary Decrease Increase Increasing government spending
F E Recessionary Increase Decrease
Decreasing interest rates M E Recessionary Increase Decrease Decreasing government transfers
F C Inflationary Decrease Increase
Increasing money supply M E Recessionary Increase Decrease
- Determine the likely effect of each of the following on AD – or – SRAS (only one shift, negative or positive) and the resulting impacts on the economy. Effect on AD Effect on SRAS Impact on Price Level
Impact on Real GDP Impact on Unemployment An increase in minimum wage
No change Decrease Increase Decrease Increase
Pessimistic consumer expectations
Decrease No change Decrease Decrease Increase
A decrease in stock (inventory)
No change Increase Decrease Increase Decrease
An decrease in the cost of oil
No change Increase Decrease Increase Decrease
Expansionary fiscal policy
Increase No change Increase Increase Decrease
A decrease in the quantity of money
Decrease No change Decrease Decrease Increase
Contractionary fiscal policy
Decrease No change Decrease Decrease Increase
A decrease in wealth Decrease No change Decrease Decrease Increase
A significant improvement in technology
No change Increase Decrease Increase Decrease
- For each of the following scenarios, label the correct panel illustrating the correct shift.
In the short run, an increase in investment spending is illustrated by: A
In the short run, an increase in net exports is illustrated by: _A _
In the short run, an decrease in wages is illustrated by: _ C_
In the short run, an increase in wages is illustrated by: _ D_
Trisem 252022-23 BMT6111 TH VL2022230300008 Reference Material I 12-11-2022 MPC MPS 3
Course: Mathematics
University: Sikkim Manipal University
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