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Chapter 11: Q4. (page 236)

Other things equal, what effect will each of the following changes independently have on the equilibrium level of real GDP in a private closed economy?

  1. A decline in the real interest rate.

  2. An overall decrease in the expected rate of return on investment.

  3. A sizable, sustained increase in stock prices.

Short Answer

Expert verified

  1. Equilibrium real GDP will increase.

  2. Equilibrium real GDP will reduce.

  3. Equilibrium real GDP will increase.

Step by step solution

01

Step 1. Explanation for part (a)

A decline in the real interest rate means lower investment costs. As a result, the investment will increase. Other things being constant, a higher investment expenditure will boost the overall spending of the economy. It will create an imbalance between output produced and purchased.

The real GDP will rise to reach the equilibrium level of spending.

02

Step 2. Explanation for part (b)

Other things being constant, if the expected rate of return declines, the aggregate investment demand will fall, ultimately reducing the investment expenditure of the economy.

Lower total spending will again disturb the equilibrium real GDP. Therefore, firms will have to cut down the production, and equilibrium real GDP will decline.

03

Step 3. Explanation for part (c)

A sizeable, sustained increase in stock prices increases the wealth of individuals, which will increase their disposable income, and thus the consumption expenditure will increase.

Enormous consumption expenditure will increase the total spending of the economy, and output will be underproduced. To maintain the equilibrium, the firms have to expand their production. Therefore, the equilibrium real GDP will increase.

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Most popular questions from this chapter

Refer to columns 1 and 6 in the table for problem 5. Incorporate government into the table by assuming that it plans to tax and spend \(20 billion at each possible level of GDP. Also, assume that the tax is a personal tax and that government spending does not induce a shift in the private aggregate expenditures schedule. What is the change in equilibrium GDP caused by the addition of government?

(1) Real Domestic Output (GDP = DI), Billions

(2) Aggregate Expenditures, Private Closed Economy, Billions

(3) Exports, Billions

(4) Imports, Billions

(5) Net Exports, Billions

(6) Aggregate Expenditures, Private Open Economy, Billions

\)200

\(240

\)20

\(30

-\)10

$230

250

280

20

30

-10

270

300

320

20

30

-10

310

350

360

20

30

-10

350

400

400

20

30

-10

390

450

440

20

30

-10

430

500

480

20

30

-10

470

550

520

20

30

-10

510

Assume that, without taxes, the consumption schedule of an economy is as follows.

GDP, Billions

Consumption, Billions

\(100

\)120

200

200

300

280

400

360

500

440

600

520

700

600

  1. Graph this consumption schedule and determine the MPC.

  2. Assume now that a lumpsum tax is imposed such that the government collects $10 billion in taxes at all levels of GDP. Graph the resulting consumption schedule and compare the MPC and the multiplier with those of the pretax consumption schedule.

Question: If an economy has an inflationary expenditure gap, the government could attempt to bring the economy back toward the full-employment level of GDP by _______ taxes or _______ government expenditures.

  1. increasing; increasing

  2. increasing; decreasing

  3. decreasing; increasing

  4. decreasing; decreasing

By how much will GDP change if firms increase their investment by $8 billion and the MPC is 0.80? If the MPC is 0.67?

Refer to the accompanying table in answering the questions that follow:

(1) Possible Levels of Employment, Millions

(2) Real Domestic Output, Millions

(3) Aggregate Expenditures (Ca + Ig+ Xn+ G), Millions

90

\(500

\)520

100

550

560

110

600

600

120

650

640

130

700

680

  1. If full employment in this economy is 130 million, will there be an inflationary expenditure gap or a recessionary expenditure gap? What will be the consequence of this gap? By how much would aggregate expenditures in column 3 have to change at each level of GDP to eliminate the inflationary expenditure gap or the recessionary expenditure gap? What is the multiplier in this example?

  2. Will there be an inflationary expenditure gap or a recessionary expenditure gap if the full employment level of output is $500 billion? By how much would aggregate expenditures in column 3 have to change at each level of GDP to eliminate the gap? What is the multiplier in this example?

  3. Assuming that investment, net exports, and government expenditures do not change with changes in real GDP, what are the values of the MPC, the MPS, and the multiplier?
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