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Chapter 21: Q 7. (page 566)
Why does equilibrium output increase as the marginal propensity to consume increases?
Increase in Marginal Propensity to consume leads to higher consumption levels, & latter is a part of Aggregate Demand. Rise in AD increases equilibrium output.
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Why do companies cut production when they find that their unplanned inventory investment is greater than zero? If they didn鈥檛 cut production, what effect would
this have on their profits? Why?
Go to the St. Louis Federal Reserve FRED database, and find data on Real Private Domestic Investment (GPDIC1), a measure of the real interest rate; the 10-year Treasury Inflation-Indexed Security, TIIS (FII10); and the spread between Baa corporate bonds and the 10-year U.S. treasury (BAA10YM), a measure of financial frictions. For (FII10) and (BAA10YM), convert the frequency setting to 鈥渜uarterly,鈥� and download the data into a spreadsheet. For each quarter, add the (FII10) and (BAA10YM) series to create ri , the real interest rate for investments for that quarter. Then calculate the change in both investment and ri as the change in each variable from the previous quarter.
a. For the eight most recent quarters of data available, calculate the change in investment from the previous quarter, and then calculate the average change over the eight most recent quarters.
b. Assume there is a one-quarter lag between movements in ri and changes in investment; in other words, if ri changes in the current quarter, it will affect investment in the next quarter. For the eight most recent lagged quarters of data available, calculate the onequarter-lagged average change in ri .
c. Take the ratio of your answer from part (a) divided by your answer from part (b). What does this value represent? Briefly explain.
d. Repeat parts (a) through (c) for the period 2008:Q3 to 2009:Q2. How do financial frictions help explain the behavior of investment during the financial crisis? How do the coefficients on investment compare between the current period and the financial crisis period? Briefly explain.
Why is inventory investment counted as part of aggregate spending if it isn鈥檛 actually sold to the final end user?
In each of the following cases, determine whether the IS curve shifts to the right or left, does not shift, or is indeterminate in the direction of shift.
a. The real interest rate rises.
b. The marginal propensity to consume declines.
c. Financial frictions increase.
d. Autonomous consumption decreases.
e. Both taxes and government spending decrease by the same amount.
f. The sensitivity of net exports to changes in the real interest rate decreases.
g. The government provides tax incentives for research and development programs for firms.
鈥淪ince inventories can be costly to hold, firms鈥� planned inventory investment should be zero, and firms should acquire inventory only through unplanned inventory
accumulation.鈥� Is this statement true, false, or uncertain? Explain your answer
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