Understanding Keynesian Model in Action

1. Chapter 19 Practice Quiz TutorialThe Keynesian Modelin Action ©2000 South-Western College Publishing

2. 1. The net exports line can be a. positive. b. negative. c. zero. d. any of the above. D. Because net exports equals exports minus imports (X-M), the sign of net exports depends on the values of X and M.

3. 2. There will be unplanned inventory investment accumulation when • aggregate output (real GDP) equals aggregate expenditures. b. aggregate output (real GDP) exceeds aggregate expenditures. c. aggregate expenditures exceed aggregate output (real GDP). d. firms increase output. B.

4. 10 The Keynesian Aggregate Expenditures-Output Model 9 8 AE = Y 7 Inventory Accumulation 6 E AE 5 Real Aggregate Expenditures C + I + G + (X-M) 4 3 2 Inventory Depletion 1 Real GDP 0 2 10 1 7 8 9 3 6 4 5

5. 3. John Maynard Keynes proposed that the multiplier effect can correct an economic depression. Based on this theory, an increase in equilibrium output would be created by an initial a. increase in investment. b. increase in government spending. c. decrease in government spending. d. both (a) and (b). e. both (a) and (c). D. A decrease in government spending is multiplied times the spending multiplier and decreases equilibrium output.

6. 4. The spending multiplier is defined as a. 1/(1 - marginal propensity to consume). b. 1/(marginal propensity to consume). c. 1/(1 - marginal propensity to save). d. 1/(marginal propensity to consume + marginal propensity to save). A. The spending multiplier is also defined as 1/MPS.

7. 5. If the value of the marginal propensity to consume (MPC) is 0.50, the value of the spending multiplier is a. .5. b. 1. c. 2. d. 5. C. Spending multiplier = 1/(1-MPC) = 1/(1-0.5) = 1/0.50 = 1/50/100 = 2.

8. 6. If the marginal propensity to consume (MPC) is 0.80, the value of the spending multiplier is a. 2. b. 5. c. 8. d. 10. B. Spending multiplier = 1/(1-MPC = 1/(1-0.80) = 1/20/100 = 5.

9. 7. If the marginal propensity to consume (MPC) is 0.75, a $50 billion decrease in government spending would cause equilibrium output to a. increase by $50 billion. b. decrease by $50 billion. c. increase by $200 billion. d. decrease by $200 billion. D. Change in equilibrium output (DY) = spending multiplier x change in government spending. Rewritten, DY = 1/(1-0.75) x -$50 billion = $200 billion = 4 x - $50 billion.

10. 8. If the marginal propensity to consume (MPC) is 0.90, a $100 billion increase in planned investment expenditure, other things being equal, will cause an increase in equilibrium output of a. $90 billion. b. $100 billion. c. $900 billion. d. $1,000 billion. D. Change in equilibrium output (DY) = spending multiplier x change in investment expenditure. Rewritten, DY = 1/(1-0.90) x $100 billion = 10 x $100 billion.

11. 9. Keynes’ criticism of the classical theory was that the Great Depression would not correct itself. The multiplier effect would restore an economy to full employment if a. government would follow a “least government is the best government” policy. b. government taxes were increased. c. government spending were increased. d. government spending were decreased. C. Keynes’ prescription to cure the Great Depression was for government to play an active role rather than depend on the classical theory that the price system will eventually restore full employment.

12. 10. The equilibrium level of real GDP is $1,000 billion, the full employment level of real GDP is $1,250 billion, and the marginal propensity to consume (MPC) is 0.60. The full-employment target can be reached if government spending is by a. $60 billion. b. $100 billion. c. $250 billion. d. held constant. B. Change in real GDP required = spending multiplier x change in government spending (DG). Rewritten, DG = 1/(1 - 0.60) x ($1,250 - $1,000) DG x 2.5 = $250 DG = $100 billion.

13. 11. In Exhibit 9, the spending multiplier for this economy is equal to a. 1 2/3. b. 2 1/2. c. 3. d. 5. B. 1/(1-MPC) = 1/(1-3/5) = 1/ 2/5 = 5/2 = 2 1/2

14. 10 Exhibit 9: The Keynesian Aggregate Expenditures-Output Model 9 8 7 MPC = 3/5 AE1 6 5 E Real Aggregate Expenditures 4 3 2 1 Real GDP 0 7 9 1 2 3 4 5 6 8 10

15. 12. To close the recessionary gap and achieve full-employment real GDP as shown in Exhibit 9, the government should increase spending by a. $1.0 trillion. b. $1.2 trillion. c. $2.0 trillion. d. $2.5 trillion. B. Change in government spending (DG) x spending multiplier = change in real GDP (DY) spending multiplier (SM) = 1/(1-MPC) = 1/(1-3/5) = 1/2/5 = 5/2 DG x 5/2 = $3 trillion DG = 2/5 x $3 trillion DG = 6/5 = $1.2 trillion

16. 10 Exhibit 9: The Keynesian Aggregate Expenditures-Output Model 9 8 7 MPC = 3/5 AE1 6 5 E Real Aggregate Expenditures 4 3 2 Full Employment 1 Real GDP 0 7 9 10 1 2 3 4 5 6 8

17. 10 Exhibit 9: The Keynesian Aggregate Expenditures-Output Model 9 AE2 E2 8 7 a MPC = 3/5 AE1 6 5 E1 Recessionary Gap=$1.2 trillion 4 Real Aggregate Expenditures 3 2 Full Employment 1 Real GDP 0 7 9 10 1 2 3 4 5 6 8

18. 13. To close the recessionary gap and achieve full-employment real GDP as shown in Exhibit 9, the government should cut taxes by a. $.60 trillion. b. $1 trillion. c. $2 trillion. d. $3 trillion. C. Change in taxes (DT) x tax multiplier = change in real GDP (DY) spending multiplier (SM) = 1/(1-MPC) = 1/(1-3/5) = 1/2/5=5/2 tax multiplier = (1-SM) = (1-5/2) = -3/2 DT x -3/2 = $3 trillion DT = -2/3 x $3 trillion DT = $2 trillion

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