ECO 200-810 Principles of Macroeconomics Spring 2001 Homework #3 Answer Key

  1. Use the table below to answer the following questions.
Income Consumption Net exports Investment Government Aggregate Expenditures
0  120
10
100
110
  340
100  200
10
100
110
  420
200  280
10
100
110
  500
300  360
10
100
110
  580
400  440
10
100
110
  660
500  520
10
100
110
  740
600  600
10
100
110
  820
    1. If the consumption function is 120 + .8Y, fill in the table above.

      2.  
    2. What is the equilibrium level of expenditures?

      3. Y = AE = C+I+G+NX = 120 +.8Y + 10 + 100 + 110
      Y = 340 + .8Y
      .2Y = 340
      Y = 1700
       
    3. Calculate the multiplier.

      4. MPC = .8  (slope of the consumption function in part a)
      multiplier = 1/(1-MPC)
      multiplier = 1/(1-.8)
      multiplier = 1/.2
      multiplier = 5
       
    4. If investment falls to 80, what is the change in equilibrium expenditure?

      5. If I falls to 80, then I decreases by 20.
      So, change in AE equilibrium = 20 x multiplier = 20 x 5 = 100
      If investment decreases by 20, then equilibrium expenditures fall by 100
  1. Describe the impact of each of the following on the consumption function and aggregate demand:
    1. The tanking stock market wipes out 30% of stock market wealth.

      2. The decrease in wealth decreases autonomous consumption.
      The consumption function decreases and AD decreases
       
    2. Bankruptcy legislation makes it easier to get a credit card after declaring bankruptcy.

      3. The increased availability of credit increases autonomous consumption.
      The consumption function increases and AD increases.
       
    3. Interest rates fall.

      4. The lower cost of credit increases autonomous consumption.
      The consumption function increases and AD increases.
  2. Contrast the views of Keynes with those of the Classical economists about the nature of and remedies for business cycles. Be sure to include the role of wage and price changes.

    3.  

     

    The classicals and Keynes differed in several respects.  The classicals felt business cycles were not common or serious because market economies are inherently stable.  In the event of a recession, wages and prices would fall so that output would be sold and people would be hired.  This self-correcting mechanism depended on flexible wages and prices.  Government intervention in the economy is not necessary or desirable.  Keynes believed that market economies were inherently unstable, and that prices and wages are not flexible, which leads to long and painful recessions.  Keynes believed that government intervention was necessary to return the economy to full employment in a reasonable period of time