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164 Theory and Measurement in the Macroeconomy
4. The table below shows the lev...
May 30, 2024
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Question 4: Average and Marginal Propensities to Consume
Question 5: Monetary Base
Question 6: Reduction in Money Supply
Question 7: Financing Government Spending
Question 8: Monetarist School of Thought
Question 9: Keynesian Approach to Reducing Unemployment
Question 10: Crowding Out Effect
Question 11: Deflationary Gap
Solution
a
Average Propensity to Consume (APC): APC is the ratio of total consumption to total disposable income
b
Marginal Propensity to Consume (MPC): MPC is the change in consumption resulting from a change in disposable income
c
As disposable income increases, APC generally decreases because consumption increases at a slower rate than income
d
MPC can either increase or decrease depending on the consumption behavior of individuals
Answer
B: Decrease, Increase
Key Concept
Average and Marginal Propensities to Consume
Explanation
As disposable income increases, the average propensity to consume typically decreases, while the marginal propensity to consume can increase depending on consumption patterns.
Solution
a
Definition: The monetary base includes notes and coins in circulation and the reserves held by banks
b
Components: It consists of physical currency and reserves
c
Broader Definitions: Some definitions also include sight accounts and time deposits
Answer
B: Notes and coins in circulation plus the cash reserves of the banking system
Key Concept
Monetary Base
Explanation
The monetary base is the sum of currency in circulation and the reserves held by banks.
Solution
a
Decrease in Liquidity Ratios: This would increase the money supply
b
Decrease in Interest Rates: This would also increase the money supply
c
Increase in Budget Surplus: This would reduce the money supply
d
Increase in Current Account Surplus: This would not directly affect the money supply
Answer
C: An increase in the budget surplus
Key Concept
Money Supply Reduction
Explanation
An increase in the budget surplus reduces the money supply by reducing the amount of money available for spending.
Solution
a
Increasing Income Tax Rates: This would not increase the money supply
b
Decreasing Income Tax Rates: This would increase disposable income but not directly the money supply
c
Sale of Government Bonds to Non-Bank Sector: This would not increase the money supply
d
Sale of Treasury Bills to Banking Sector: This would increase the money supply
Answer
D: The sale of treasury bills to the banking sector
Key Concept
Government Financing and Money Supply
Explanation
Selling treasury bills to the banking sector increases the money supply as banks create money through lending.
Solution
a
Increase in Money Supply: Monetarists believe it leads to inflation if it exceeds real GDP growth
b
Productive Capacity: Monetarists do not believe money supply increases productive capacity
c
Government Action: Monetarists believe government action cannot reduce unemployment in the long run
d
Aggregate Demand: Monetarists focus on money supply rather than aggregate demand
Answer
B: If the money supply increases by a greater percentage than real GDP, prices will rise
Key Concept
Monetarist Theory
Explanation
Monetarists believe that an increase in the money supply greater than the growth of real GDP leads to inflation.
Solution
a
Increased Budget Deficit: Keynesians support this to boost aggregate demand
b
Increased Unemployment Benefits: This increases disposable income and consumption
c
Tax Cuts: This also increases disposable income and consumption
Answer
A: An increased budget deficit, increased unemployment benefits, and tax cuts
Key Concept
Keynesian Economics
Explanation
Keynesians advocate for increased government spending and tax cuts to reduce unemployment by boosting aggregate demand.
Solution
a
Public Sector Borrowing: Increases demand for loanable funds
b
Interest Rates: Increased borrowing leads to higher interest rates
c
Private Sector Investment: Higher interest rates reduce private sector investment
Answer
D: Increase, Decrease
Key Concept
Crowding Out Effect
Explanation
Increased public sector borrowing raises interest rates, which in turn reduces private sector investment.
Solution
a
Full Employment Level: Represented by Yfe
b
Deflationary Gap: The distance between current output and full employment output
c
Graph Analysis: In Figure 15.8, the deflationary gap is represented by the distance TR
Answer
B: TR
Key Concept
Deflationary Gap
Explanation
The deflationary gap is the difference between the current level of output and the full employment level of output, represented by TR in the graph.
Solution
a
Monetarist Concept: According to the monetarist school of thought, if the money supply increases by a greater percentage than real GDP, prices will rise. This is because monetarists believe that inflation is always and everywhere a monetary phenomenon
Answer
B
Key Concept
Monetarist theory emphasizes the relationship between money supply and inflation.
Explanation
Monetarists argue that an increase in the money supply that outpaces real GDP growth will lead to inflation.
Solution
a
Keynesian Policy Measures: A Keynesian approach to reducing unemployment typically involves increasing aggregate demand through government spending and monetary policy
Answer
D
Key Concept
Keynesian economics focuses on boosting aggregate demand to reduce unemployment.
Explanation
Keynesians believe that government intervention can help reduce unemployment by increasing aggregate demand.
Solution
a
Distance WX: In the context of aggregate expenditure in an open economy, the distance WX represents savings
Answer
C
Key Concept
Savings in the context of aggregate expenditure.
Explanation
The distance WX in the graph represents the amount of income not spent on consumption, which is savings.
Solution
a
Equilibrium Level of Income: In a closed economy with a government sector, the equilibrium level of income is represented by point C
Answer
C
Key Concept
Equilibrium income in a closed economy.
Explanation
The equilibrium level of income is where aggregate demand equals aggregate supply.
Solution
a
Injection into Circular Flow: Spending by domestic firms on capital goods is an injection into the circular flow of income
Answer
B
Key Concept
Injections in the circular flow of income.
Explanation
Injections include investments, government spending, and exports.
Solution
a
Multiplier Calculation: The multiplier is calculated as mps+mrt+mpm1=0.1+0.05+0.051=5
Answer
C
Key Concept
Multiplier effect in macroeconomics.
Explanation
The multiplier effect shows how initial spending leads to increased total economic activity.
Solution
a
Government Spending Increase: To raise national income to the full employment level, the government needs to increase its spending by multiplier140−90=1−(0.1+0.1+0.2)50=50 billion
Answer
D
Key Concept
Government spending and national income.
Explanation
The required increase in government spending is calculated using the multiplier effect.
Solution
a
Accelerator Theory: The accelerator theory suggests that investment is a function of the growth of income
Answer
C
Key Concept
Accelerator theory in macroeconomics.
Explanation
The theory posits that higher income growth leads to increased investment.
Solution
a
Loanable Funds Theory: According to the Loanable Funds Theory, a decrease in the level of savings will cause the rate of interest to rise
Answer
B
Key Concept
Loanable Funds Theory and interest rates.
Explanation
Lower savings reduce the supply of loanable funds, increasing interest rates.
Solution
a
Speculative Reasons for Holding Money: People hold money for speculative reasons if they expect the price of government bonds to fall
Answer
A
Key Concept
Speculative demand for money.
Explanation
Holding money to avoid losses from falling bond prices.
Solution
a
New Equilibrium Position: When commercial banks give more loans and the transactions demand for money increases, the new equilibrium position is at point D
Answer
D
Key Concept
Equilibrium in the money market.
Explanation
Increased loan supply shifts the money demand curve.
Solution
a
Required Rate of Interest: To achieve the full employment level of income, the required rate of interest is 10%
Answer
C
Key Concept
Interest rates and full employment income.
Explanation
The rate of interest affects investment and thus the level of income.
Solution
a
Rise in Consumer Expenditure: If exports increase by 200 m, the rise in consumer expenditure is 0.75200=600 m
Answer
C
Key Concept
Impact of exports on consumer expenditure.
Explanation
Increased exports lead to higher income and thus higher consumer spending.
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