CHAPTER 23
THE SHORT-RUN MACRO MODEL
ANSWERS, SOLUTIONS AND EXERCISES
ANSWERS TO ONLINE REVIEW QUESTIONS
2. The marginal propensity to consume is (1) the slope of the consumption function; (2) the
change in consumption divided by the change in disposable income; or (3) the amount by
which consumption spending rises when disposable income rises by one dollar.
4. The two components of planned investment or investment spending are business
purchases of plant and equipment and new home construction. Actual investment
includes these two categories as well as changes in business inventories.
6. If government spending increases, then firms that sell goods and services to the
government will earn additional revenue, which will end up going to the factors of
production that produced those goods, increasing household income. The increase in
income leads households to increase spending, increasing the revenue of firms that
produce consumption goods. Income increases once again, leading to a further increase
in spending, and so on. In the end, GDP will rise by a multiple of the increase in
government spending.
8. An automatic stabilizer is a force that interferes with, and reduces the size of, the
multiplier effect. Some automatic stabilizers for the U.S. economy include taxes, transfer
payments, interest rates, prices, imports, and consumer behavior.
10. No. In the classical long-run model, fiscal policy is completely ineffective due to the
crowding out effect. In the short-run macro model, however, an increase in
government purchases causes a multiplied increase in equilibrium GDP.
PROBLEM SET
2. a.
Real GDP
$0
$100
$200
$300
$400
$500
$600
Autonomous
Consumption
$30
$30
$30
$30
$30
$30
$30
MPC x Disposable
Income
$0
$85
$170
$255
$340
$425
$510
Consumption =
Autonomous
Consumption +
(MPC x Disposable
Income)
$30
$115
$200
$285
$370
$455
$540
b.
Real GDP
$0
$100
$200
$300
$400
$500
$600
Consumption
Spending
$30
$115
$200
$285
$370
$455
$540
Planned
Investment
$40
$40
$40
$40
$40
$40
$40
Government
Spending
$20
$20
$20
$20
$20
$20
$20
Net Exports
-$15
-$15
-$15
-$15
-$15
-$15
-$15
Aggregate
Expenditures
$75
$160
$245
$330
$415
$500
$585
c.
d. $500 billion is the equilibrium level of real GDP.
e. If the actual level of real GDP in this economy is $200 billion, then the economy will
expand. This is because aggregate expenditure ($245 billion) is greater than real GDP
($200 billion), so firms find their inventories falling, and will expand output, leading
to a higher real GDP in the future.
f. If planned investment falls to $25 billion, the equilibrium level of real GDP will fall
from $500 billion to $400 billion.
4.
a. Inventories will fall unexpectedly, sending firms a signal to produce more output.
GDPA is not sustainable because the extra production will move the economy to the
right along the horizontal axis.
b. Inventories will rise unexpectedly, sending firms a signal to produce less output.
GDPB is not sustainable because cut in production will move the economy to the left
along the horizontal axis.
6. a. Real GDP and total employment will increase.
b. Real GDP and total employment will increase.
c. Real GDP and total employment will decrease.
8. a. In the table in Problem 1, the second column (C) would be affected; each number in
the column would become smaller, since households would spend less at each level of
income.
b. The change in saving is the vertical distance between the two aggregate expenditure
lines.
c.
Real
Aggregate
Expenditure
(C + I + NX) 1
(C + I + NX) 2
45°
Y2
10.
Y1
Real
GDP
a. If the MPC is 0.95, then the expenditure multiplier is 20. Therefore, the change in real
GDP is 20 x $7,500 = $150,000.
b. If the MPC is 0.65, then the expenditure multiplier is 2.86. Therefore, the change in
real GDP is 2.86 x -$300,000 = -$857,143.
c. If the MPC is 0.75, then the expenditure multiplier is 4. Therefore, the change in real
GDP is 4 x -$5 billion = -$20 billion.
12.
Additional
increase in I
Round
Initial Increase in Investment
Spending
2
3
4
5
Additional
Spending in
each round
Total
Additional
Spending
1000
1000
1000
90
62
43
30
690
476
329
227
1690
2166
2495
2721
The final change in GDP would be higher than $2,500 billion, because further rises in
investment act as a de-stabilizer, thus increasing the multiplier.
MORE CHALLENGING
14. Y = [a – (b  T) + IP + G + NX] / (1 – b) = [600 – (0.75  400) + 600 + 700 + 200] / (1 –
0.75) = 7,200. At this equilibrium, C = a + b(Y – T) = 600 + 0.75(7,200 – 400) = 5,700.
Therefore, in equilibrium, we have aggregate expenditure = C + IP + G + NX = 5,700 +
600 + 700 + 200 = 7,200, which is equal to equilibrium real GDP.
16.
S + T,
I + G + NX
S+ T
I 2 + G + NX
I 1 + G + NX
0
Y1
Y2
Real
GDP
The two lines cross at the equilibrium output level, where S + T = IP + G + NX. If
investment spending increased, the IP + G + NX line would shift upward. The new
crossing point would occur at a higher level of real GDP, so equilibrium real GDP would
increase.