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University of British Columbia Econ 102 Tutorial 4 1) Consider an economy characterized by the following equations: C = 500 + 0 + 0 I = 150 where C is desired consumption, I is desired investment, W is household wealth, and Y is national income. a) Why the consumption function is C = 500 + 0, not C ...

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University of British Columbia Econ 102 Tutorial 4 1) Consider an economy characterized by the following equations: C = 500 + 0.75Y + 0.05W I = 150 where C is desired consumption, I is desired investment, W is household wealth, and Y is national income. a) Why the consumption function is C = 500 + 0.75Y, not C = 500 + 0.75YD as we saw in class? b) Suppose wealth is constant at W = 10000. Draw the aggregate expenditure (AE) function on a scale diagram along with the 45 line. What is the equilibrium level of national income? c) The marginal propensity to consumption in this economy is 0.75. What is the value of the simple multiplier? d) Using your answer from part b), what would be the change in national income if desired investment increased to 250? Can you show this in your diagram? e) Now suppose household wealth increases from 10000 to 15000 in addition to the change in c). Draw the new AE function on the same graph as a). What happens to the C and AE function and by how much does the equilibrium national income change? a) YD = Y - Tax. Since so far the government is missing in the model, there is no tax and Y = Y D. b) See the figure below. When wealth is 10000, the AE function is AE = 500 + 0.75Y + (.05)(10000) + 150 ⇒ AE = 1150 + 0.75Y Using the equilibrium condition, Y = AE, the equilibrium level of national income is the level of Y that solves the following equation: Y = 1150 + 0.75Y ⇒ Y(1 – 0.75) = 1150 ⇒ Y = 1150/.25 ⇒ Y = 4600

c) The value of the simple multiplier is 1/(1 – MPC). In this economy, MPC = 0.75 and so the value of the simple multiplier is 1/(1 – 0.75) = 1/(0.25) = 4. d) If desired investment increases from 150 to 250, this is an increase in autonomous expenditure of 100. Given the multiplier of 4, the change in equilibrium national income will be 400. This is shown in the diagram above as the AE function shifts to AE′ and equilibrium national income rises to 5000. e) Let’s suppose that I has already increased to 250 as in part (c). If wealth now increases from 10000 to 15000, the level of autonomous consumption increases by 5000(.05) = 250. C = 500 + 0.5Y + 0.05(15000) = 1250 + 0.5Y Thus the new AE function becomes AE = 1500 + (.75)Y As households increase their autonomous consumption by 250, the AE function shifts up by 250 and the equilibrium level of national income increases by 250×4 = 1000. Equilibrium national income rises to 6000.

Y (trillions of dollars) 1.0 2.0 3.0 4.0 5.0 6.0

C (trillions of dollars) 1.00 1.65 2.30 2.95 3.60 4.25

Table 27.2.1 I G (trillions of (trillions of dollars) dollars) 0.5 0.7 0.5 0.7 0.5 0.7 0.5 0.7 0.5 0.7 0.5 0.7

X (trillions of dollars) 0.45 0.45 0.45 0.45 0.45 0.45

M (trillions of dollars) 0.15 0.30 0.45 0.60 0.75 0.90

2) Table 27.2.1 gives the aggregate expenditure schedule. Equilibrium expenditure is equal to ________. A) $4 trillion B) $3 trillion C) $5 trillion D) zero E) $2 trillion Answer: A 3) Table 27.2.1 gives the aggregate expenditure schedule. Marginal propensity to import is equal to ________. A) 0.01 B) 0.05 C) 0.10 D) 0.15 E) 0.20 Answer: D 4) Table 27.2.1 gives the aggregate expenditure schedule. If MPC = 0.8, net tax rate is equal to ________. A) 0.1575 B) 0.1675 C) 0.1775 D) 0.1875 E) 0.1975 Answer: D 5) If there is a decrease in autonomous expenditure, the new AE curve is A) flatter than the original AE curve. B) steeper than the original AE curve. C) parallel and above the original AE curve. D) parallel and below the original AE curve. E) none of the above. Answer: D 6) All else constant, a decrease in the income tax rate will result in A) a movement down along the aggregate expenditure curve. B) an upward shift of the AE curve with no change in its slope. C) a downward shift of the AE curve with no change in its slope. D) a decrease in the consumption expenditure. E) an AE curve with a steeper slope. Answer: E

7) Everything else remaining the same, which one of the following would increase equilibrium real GDP? A) an increase in saving B) an increase in exports C) a decrease in investment D) an increase in taxes E) a decrease in exports Answer: B 8) The slope of the AE curve equals A) aggregate expenditure divided by real GDP. B) the change in aggregate expenditure divided by the change in real GDP. C) the change in consumption divided by the change in real GDP. D) the change in consumption plus government expenditure divided by the change in aggregate income. E) the change in income divided by the change in autonomous expenditure. Answer: B...