Mr. Beck

SUNY College at Oneonta

Economics 110  Recent Exam 2  Questions- Solutions

Homepage

Review Questions for Economics 110

1. If the quantity produced of all goods and services remains constant from year 1 to year 2, this indicates that real (constant $) GDP remains constant. However, if prices increase by 10%, then money GDP (which equals price x quantity of all goods and services) will also increase by 10%. The correct choice is e.
Return to Question 1



2. Real GDP = Money GDP/Price Level. If the denominator, the price level increases, then real GDP can only increase if the numerator, money GDP, increases by more than prices increase.
    The fact that prices have increased ensures that real GDP would not increase as much as money GDP. Only if prices were to remain constant would real GDP increase at the same rate that money GDP increases.
    The correct choice is d, money GDP increased by a larger percent than both real GDP and prices increased.
Return to Question 2

3. Real (Constant $) GDP = (Money GDP/Price Level Index) x 100

For 2001: Real GDP = (10,130B/102.4)  x 100 = 98.93B x 100  = 9893B

For 2004: Real GDP = (11,360B/108.3)  x 100 = 104.89B x 100  = 10,489B

% D =  [(New Value - Original Value)/Original Value] x 100         (D = change)

% D =  [(10,489B - 9893B)/9893B] x 100  =  596B/9893B  x 100   =  .06 x 100 = 6%.
Return to Question 3



4. Real GDP = Money GDP/Price Level.
The numerator, money GDP, increases by a smaller percent than the denominator, the price level, increases. The result is that the ratio, Real GDP, decreases, choice a.
Return to Question 4
5. Real GDP = Money GDP/Price Level.    If the numerator (Money GDP) increases 6 times and the denominator (price level) increases 2 times, then the ratio (Real GDP) increases 3 times. 6/2 = 3. Real GDP triples, choice b.
Return to Question 5

6. Real (Constant $) GDP = (Money GDP/Price Level Index) x 100

For 1974: Real GDP = (1,400B/116)  x 100 = 12.07B x 100  = 1207B

For 1977: Real GDP = (1,900B/140)  x 100 = 13.57B x 100  = 1357B

% D =  [(New Value - Original Value)/Original Value] x 100         (D = change)

% D =  [(1357B - 1207B)/1207B] x 100  =  150B/1207B  x 100   =  .124 x 100 = 12.4%. Rounded off to the nearest %, 12%.
Return to Question 6



7. Real GDP = Money GDP/Price Level. If the denominator (price level) doubles, then for Real GDP (the ratio) to double, the numerator (money GDP) must increase by 4 times.  2 = Money GDP/2.  Money GDP = 2 x 2 = 4.  A 4-fold increase in money GDP would increase it from $2,250B to $2,250B x 4 = $9,000B.
Return to Question 7

8. Real GDP = Money GDP/Price Level.  The only way for the ratio (real GDP) to increase by a greater percent than the numerator (Money GDP) is if the denominator (the price level) actually decreased, choice e.
    If the denominator (the price level) increased, then the ratio would not increase by as much as the numerator. (Depending upon how much the denominator increased, the ratio might remain constant or even decrease.)
Return to Question 8

9. Real GDP = Money GDP/Price Level. If the ratio (real GDP) doubles and the denominator (the price level) triples, then the numerator (money GDP) must have increased by 6 times from 1955 to 1978. 2 = Money GDP/3. Money GDP = 2 x 3 = 6. The correct choice is e.
Return to Question 9

10. Real GDP = Money GDP/Price Level.  If the numerator (money GDP) falls and the denominator (price level) rises, then the ratio (real GDP) will decrease by a larger percentage than money GDP decreased, choice c.
    If the price level had remained constant, then real GDP would have decreased by the same percentage as money GDP had decreased. The increase in the denominator (the price level) adds another reason for the decrease in real GDP, resulting in real GDP decreasing by a larger percentage than the numerator (money GDP) decreased.
Return to Question 10

11. Real GDP = Money GDP/Price Level. If the denominator (price level) triples, then for Real GDP (the ratio) to double, the numerator (money GDP) must increase by 6 times.  2 = Money GDP/3.  Money GDP = 2 x 3 = 6.  A 6-fold increase in money GDP from 1976 to 1997 would increase it from $2,000B to ($2,000B x 6) = $12,000B.
Return to Question 11

12. Real GDP = Money GDP/Price Level. The combination of increases in money GDP and decreases in the price level is the best of all possible worlds. More money GDP and a lower price level  means that real GDP has increased for both reasons. A larger numerator (money GDP) combined with a smaller denominator (price level) results in a much larger ratio (real GDP).
    If prices had remained constant, then real GDP would have increased by the same percent as money GDP. But, in this case, with the decrease in the price level, real GDP will have increased by a greater percentage than money GDP increased. The correct choice is a.
Return to Question 12

13. If production of all goods and services remain constant from year 1 to year 2, this indicates that real (constant $) GDP remains constant. However, if prices double, then money GDP (which equals price x quantity of all goods and services) will double. The correct choice is f.
Return to Question 13

14. Real (Constant $) GDP = (Money GDP/Price Level Index). If the numerator, money GDP, exactly doubled, then for the ratio, real GDP to remain constant, the denominator, the price level index, must also have exactly doubled, choice c. This is because 1 = (2/2). If money GDP doubled, then for people's real incomes to remain constant, they must be paying twice as much money for the items they buy.
Return to Question 14

15. This is a 3-step problem.
Step 1: Compute 1998's real GDP using the formula: Real (Constant $) GDP = (Money GDP/Price Level Index)  x 100
    Real GDP for 1998 = ($8,780 billion/103.2) x 100 =  $85.08 billion x 100 = $8,508 billion.

Step 2: Compute 2002's real GDP using the formula: Real (Constant $) GDP = (Money GDP/Price Level Index)  x 100
    Real GDP for 2002 = ($10,500 billion/109.2) x 100 =  $96.15 billion x 100 = $9,615 billion.

Step 3:  % D =  [(New Value - Original Value)/Original Value]  x 100
    [($9,615 billion - $8,508 billion)/$8,508 billion] x 100
    $1,107 billion/$8,508 billion x 100
    0.1301 x 100 = 13.01% which may be rounded off to 13%.
Return to Question 15



16. Real (Constant $) GDP = (Money GDP/Price Level Index). The only way that the ratio real GDP can decrease if the numerator (money GDP) increases is for the denominator (the price level index) to have increased by a larger percent than money GDP increased. For example, if people were to double their money earned, their real income, purchasing power, would decrease if prices were to more than double. The correct choice is a.
Return to Question 16

17. A recession would exist if real (constant $) GDP were to decrease. Real (Constant $) GDP = (Money GDP/Price Level Index). If the numerator (money GDP) remains constant, but the denominator (the price level index) doubles, then real GDP would decrease to 1/2 of its previous level. The correct choice is d.
Return to Question 17


18. Increased unemployment associated with an economic recession is due to a downturn in the economy. This is an example of cyclical unemployment. Unemployment caused by the family relocating to Phoenix represents  frictional unemployment, whereas Mr. Rudolph is temporarily unemployed until he finds a job in the new location. The correct answer is e, Mr. Rudolph is cyclically unemployed in 2001 and frictionally unemployed in 2003.
Return to Question 18

19. A worker who stops looking for a job because she believes no jobs are available is not officially unemployed because she is a temporary drop out from the labor force. Ms. Elderson is considered a discouraged worker, choice d.
Return to Question 19

20. Unemployment insurance payments represent a government transfer payment. A transfer payment is equivalent to a negative net tax as it is $ paid by the government to the household rather than from the household to the government.
Transfer payments replace part (but not all) of an unemployed worker's lost income. Therefore, if one becomes unemployed, his disposable income will still decrease, but, fortunately, by less than his income decreases. The correct choice is d
For example: Assume a worker's income is $10,000 and he pays no taxes and receives no transfer payments. His disposable income is $10,000.
    From the formula sheet: Disposable Income (DI) = Income (Y) – Taxes + Transfer Payments.
                                        $10,000 = $10,000 - 0 + 0
He loses his job. His income earned decreases to 0 but he now receives $4,000 of unemployment insurance (a transfer payment). His disposable income is now reduced not to 0, but to $4,000.
Disposable Income (DI) = Income (Y) – Taxes + Transfer Payments.
$4,000 = 0 - 0 + $4,000
In this example, although his income has decreased by $10,000 (from $10,000 to 0), his disposable income has only decreased by $6,000 (from $10,000 to $4,000).
Return to Question 20

21. Debtors (borrowers) benefit from unexpectedly high inflationary price increases because inflation reduces the real value of their debt. It becomes easier to pay off their debt as they are able to pay it off with deflated dollars which are worth less. The correct choice is e.
Return to Question 21

22. The worker was initially earning $500 per week
The worker becomes unemployed. His income earned decreases to 0 but he now receives $400 (which is 80% of $500) of unemployment insurance (a transfer payment). His disposable income is  reduced  from $500 to $400.
His disposable income would decrease by $100 per week, choice d.
Return to Question 22

23. If a worker loses his job because his skills become outdated, this is because the structure of the economy has changed. As such, we refer to him as structurally unemployed, choice a.
Return to Question 23

24. An automatic (built-in) stabilizer helps stabilize the economy, preventing it from rapidly spiraling downward into a severe recession. If a worker loses her job, she will have to decrease her consumption spending because she is poorer; however, since she receives some unemployment compensation, her disposable income does not decrease by as much as it would have decreased if she did not receive any unemployment compensation. As such, although she will still have to decrease her consumption (because unemployment compensation replaces only part of her lost earnings and she is still poorer than when she had a job), her consumption spending (C) will decrease by less than if no unemployment compensation existed. The correct choice is c.
Return to Question 24

25. Investment expenditures (I) represent spending on new capital goods purchased by U.S. businesses. Capital goods are machinery, equipment, and buildings. The purchase of the Dell computer by U.S. Steel is considered an investment expenditure while the purchase of the same Dell computer by a U.S. consumer is considered a consumption expenditure (C) by a household and the purchase by the government is listed as government purchases of goods and services (G). The correct choice is c.
Return to Question 25

26. A fall in consumer confidence will cause households to decrease their consumption spending (C). A decrease in consumption spending caused by anything other than a decrease in disposable income is shown by a shift down in the entire consumption line as shown below. The shift down represents less consumption spending at the same level of disposable income. The correct choice is b.

Graph question 26 solution
Return to Question 26



27. If  someone's wages are increased this will increase their disposable income and enable them to increase their consumption spending. Since disposable income is measured on the horizontal axis, this increase in consumption spending would be shown as a movement up and to the right along a given consumption (C) line. The correct choice is b.
Return to Question 27

28. DC = MPC x  DDI. The MPC is equal to 0.81 in this problem.
As DI decreases by $40,000 (from $100,000 to $60,000), DC = 0.81 x (-$40,000) = -$32,400.
The amount of consumption spending when DI is $60,000 is shown in the last row in the table below in column 2.
Disposable Income (DI)
Consumption (C)
$100,000 
$90,000
DDI = - $40,000
DC = - $32,400.
$60,000
 $90,000 - $32,400.= $57,600
Return to Question 28

29.  The circular flow diagram illustrates the flow of dollars throughout the economy. Transfer payments (unemployment compensation, welfare, and social security benefits) are paid by the government to eligible households. As such, the dollars flow directly from the government. The correct choice is d.
Return to Question 29

30. If Ms. Reeves receives an increase in her wages, her disposable income (DI) will increase. Part, but only part, of the additional disposable income will be used to increase her consumption spending (C). The remaining part will be saved (S). Essentially, people with higher levels of disposable income are able to spend more, and, because they have more $, they are also able to save. The correct choice is a, Ms. Reeves can be expected to increase both the annual $ amount she consumes (C) and the annual $ amount she saves (S).
Return to Question 30

31. Since Saving equals Disposable Income minus Consumption, consumption = disposable income - saving (consumption represents disposable income not saved). Row 2 in the table below illustrates that consumption will be $47,500, ($60,000  - $12,500 of saving), when disposable income is $60,000.
Disposable Income (DI)
Consumption (C)
Saving (S)
$50,000
$40,000
$60,000
$47,500
$12,500
DDI = $10,000 
DC = $47,500 - $40,000  = $7,500
Since the marginal propensity to consume (MPC) = DC/DDI
    MPC = $7,500/$10,000 = 0.75.
Return to Question 31

32. The stock market collapse of 2001 reduced Mr. Gould's assets (wealth). To replenish his lost wealth, he will be forced to save more. The only way to save more of one's annual disposable income is to consume less. This would be shown by a shift down in his consumption line from A to B. A decrease in consumption spending caused by anything other than a decrease in disposable income is shown by a shift down in the entire consumption line.
    In 2002, Mr. Gould loses his job. This will decrease his disposable income, thereby causing him to further decrease his consumption spending. Since disposable income is measured on the horizontal axis, this decrease in consumption spending would be shown as a movement down and to the left along the new lower consumption (C) line. This is illustrated below by the movement from B to N.

Graph question 32 solution
The correct choice is b. There will be a shift down in his entire consumption line followed by a movement down and to the left along the new consumption line.
Return to Question 32



33. The circular flow diagram illustrates the flow of dollars throughout the economy. Savings (S) represent dollars of disposable income (DI) which are not consumed by households. Saving (S) = DI – C. Dollars saved flow into the financial system (banks etc.). The correct choice is d.
Return to Question 33

34.
Graph question 34
Since the slope of the consumption line, the MPC, is equal to 0.61, we can calculate how much more will be consumed at a disposable income level of $90,000 (point N) than at $45,000 (point A).
DC = MPC x DDI. Since disposable income increases by $45,000 from point A to point N,
DC = 0.61 x $45,000
DC = $27,450.
Adding the additional consumption of $27,450 to the $40,000 (the amount of consumption at point A) yields a level of consumption (C) of $67,450 at point N.
Return to Question 34

35. Since Saving equals Disposable Income minus Consumption, we can determine one's saving by computing consumption and subtracting that amount from disposable income.
DC = MPC x  DDI. The MPC is equal to 0.85 in this problem.
As DI increases by $5,000  (from $60,000  to $65,000 ), DC = 0.85 x $5,000  = $4,250 .
The amount of consumption spending is shown in the table below in column 2.
Since S = DI - C, the amount of saving (S) at a disposable income level of $65,000  is calculated on the last row in column 3:
Disposable Income (DI)
Consumption (C)
Saving (S)
$60,000 
$57,000 
DDI. = $5,000 
DC = $4,250 
 
$65,000 
$57,000  + $4,250  = $61,250 
$65,000  - $61,250 = $3,750 
Return to Question 35

36. Output (real GDP) always equals income (Y). If the firm sells the item for $300, then GDP = $300. Since every $ of output produced generates exactly $1 of income, exactly $300, of income is earned, choice c. Specifically, adding the $400 of wages and the -$100 of profits yields ($400 - $100) = $300 of income earned, since both wages and profits are considered in determining income.
Return to Question 36

37. The circular flow diagram illustrates the flow of dollars throughout the economy. Disposable Income (DI) = Income (Y) – Net taxes (T).
Households earn income, but part of their income flows to the government in the form of net taxes paid. The after-tax  income, referred to as disposable income, represent dollars actually flowing to households, dollars households have available to consume or save. The correct choice is d.
Return to Question 37

38. An increase in demand for goods and services will cause businesses to increase their output produced, thereby increasing real GDP. A decrease in net taxes (T) will increase households' disposable income since disposable Income (DI) = Income (Y) – Net taxes (T). Part of the increased disposable income will be used to increase household consumption spending, thereby increasing the household demand for goods and services.
    If we add an increase in government spending (G) to this increase in household consumption spending (C), we would get the greatest resultant increase in the economy's level of real GDP. The correct choice is c, an increase in government spending (G) accompanied by a decrease in net taxes (T).
Note, however, that too large a combination of an increase in government spending and a decrease in net taxes could potentially create undesirable excess demand inflationary price increases.
Return to Question 38

39. An increase in government spending (G) will increase demand for goods and services. This is shown by a shift in the entire aggregate demand curve to the right, choice a. A shift to the right represents an increase in demand not caused by lower prices.
Return to Question 39

40. When the economy is in a recession, government stabilization policy calls for an increase in demand to stimulate the economy. Either a decrease in taxes (which would increase consumer demand) or a direct increase in government spending would effectively increase demand for goods and services. Advocates of smaller government would prefer a decrease in taxes because they do not want additional government spending.
    When the economy is in an inflationary period, government stabilization policy calls for a decrease in demand to slow down the undesirable price increases. Either an increase in taxes (which would decrease consumer demand) or a direct decrease in government spending would effectively decrease demand for goods and services. Advocates of smaller government would take this opportunity to decrease government spending.
    The correct choice is a, advocates of smaller government would decrease taxes when the economy is in a recession and decrease government spending when the economy is in an inflationary period.
Return to Question 40

41. When the economy is in a recession, government stabilization policy calls for an increase in demand to stimulate the economy. By decreasing taxes, choice e, households' disposable income would increase. Disposable Income (DI) = Income (Y) – Net taxes (T). Part of the increase in disposable income will be used by households to increase their consumption spending, thereby increasing demand for goods and services and stimulating the economy.
Return to Question 41

42. Both an increase in government spending (G) and a decrease in taxes would shift the aggregate demand curve to the right as they both represent an increase in demand for goods and services not caused by lower prices. Supply-side economists believe that tax cuts will also increase aggregate supply because it will provide incentives for workers to work more hours and for businesses to invest more in new capital goods. Thus, supply-side economists believe that tax cuts will also shift the supply curve to the right. The correct choice is b.
Return to Question 42

43. An increase in salary represents an increase in one's disposable income earned. Since disposable income is measured on the horizontal axis of the consumption line graph, an increase in disposable income would be shown as a movement to the right. As consumption and disposable income are directly (positively) related, the consumption line is positively sloped and an increase in disposable income would result in an increase in consumption spending. The increase in Mr. Lawson's salary would result in a movement up and to the right along a given consumption (C) line, choice c.
Return to Question 43

44. Saving (S) = Disposable income (DI) minus Consumption (C).
        $14,000 = $100,000 - Consumption.
    Consumption = $100,000 - $14,000 = $86,000.
DC = MPC x  DDI. The MPC is equal to 0.71 in this problem.
As DI increases by $25,000 (from $100,000 to $125,000), DC = 0.71 x ($25,000) = $17,750.
The amount of consumption spending when DI is $125,000 is shown in the last row in the table below in column 2.
Disposable Income (DI)
Consumption (C)
$100,000 
$86,000
DDI = $25,000
DC =  $17,750.
$125,000
 $86,000 + $17,750.= $103,750
Return to Question 44

45. The circular flow model tracks money ($) flows. When U.S. consumers purchase products from another country, the products are imported into the U.S., but the $ from U.S. consumers flow to the rest of the world. The correct choice is Imports (IM), choice b.
Return to Question 45


46. If Ms. Hudson becomes pessimistic about her job security, she will increase the $ amount she saves. This is designed to protect her in case she does actually lose her job. Since saving (S) = Disposable income (DI) minus Consumption (C), the only way to increase her saving from the same disposable income is for her to decrease her consumption spending. Every $ less she consumes represents an additional $ saved.
    She can be expected to decrease the annual $ amount she consumes (C), but increase the annual $ amount she saves (S), choice d.
Return to Question 46

47. Since Saving equals Disposable Income minus Consumption, consumption is $3,000 more than disposable income when disposable income is $22,000. As shown in row 1 below, consumption is $25,000 when disposable income is $22,000.
Row 2 indicates that when disposable income is $34,000, consumption is $1,440 less than disposable income since she is saving $1,440.
$34,000 - $1,440 =  $32,560.
Disposable Income (DI)
Consumption (C)
Saving (S)
$22,000 
$25,000 
-$3,000
$34,000 
$32,560 
$1,440 
The marginal propensity to consume (MPC) = DC/DDI. The change in consumption is $32,560 - $25,000 = $7,560. The change in disposable income is $34,000 - $22,000 = $12,000.
    MPC = $7,560/$12,000 = 0.63.
Return to Question 47

48. Inflation is usually caused by excess demand for goods and services bidding up prices. To eliminate the inflation, government policy is designed to decrease demand. An increase in taxes, choice b, will decrease consumers' disposable income since disposable Income (DI) = Income (Y) – Net taxes (T). The decrease in disposable income will cause consumption spending by households to decrease because consumption spending and disposable income are directly (positively) related. This reduction in consumer demand would help eliminate the inflationary price increases.
Return to Question 48

49. If households fear they may lose their job, they will increase their saving. This is designed to protect them in case they actually do lose their job. Since saving (S) = Disposable income (DI) minus Consumption (C), the only way to increase one's saving from the same disposable income is to decrease one's consumption spending. This is shown by a shift down from A to B on the graph below.
    Unfortunately, if many households reduce their consumption spending, this will result in declining business sales, As firms accumulate large amounts of unsold inventory of goods, they will begin to lay off workers, the very thing households feared in the first place. Layoffs result in loss of salary which represents a decrease in disposable income. As disposable income decreases, consumption further decreases, as shown by the movement from B to N along the new lower consumption line.
    The correct choice is c, and this is illustrated by a shift down in the economy’s entire consumption line followed by a movement down and to the left along the new consumption line.

Graph question 49 solution
Return to Question 49



50. The circular flow model tracks money ($) flows. Investment (I), choice c, is a $ amount which flows directly to the business sector because it is business spending on new capital goods (plant and equipment) produced by U.S. businesses.
Return to Question 50

51.
Graph question 51

Since the slope of the consumption line, the MPC, is equal to 0.82, we can calculate how much less will be consumed at a disposable income level of $50,000 (point N) than at $100,000 (point A).
DC = MPC x DDI. Since disposable income decreases by $50,000 from point A to point N (from $100,000 to $50,000).
DC = 0.82 x - $50,000
DC = - $41,000.
Subtracting  the decrease in consumption of $41,000 from $90,000 (the amount of consumption at point A) yields a level of consumption (C) of $49,000 at point N.
Return to Question 51



52. Saving equals Disposable Income minus Consumption,
            Saving  = $15,000 - $18,000
            Saving = - $3,000 when disposable income is $15,000. This is shown in row 1 of the table below
As shown in row 1 below, consumption is $25,000 when disposable income is $22,000.
Row 2 indicates that when disposable income is $34,000, consumption is $1,440 less than disposable income.
Disposable Income (DI)
Consumption (C)
Saving (S)
$15,000
$18,000
- $3,000
$19,000
 
 - $1,040
DDI = $19,000 - $15,000 = $4,000 
  DS = - $1,040 - (-$3,000) = $1,960
Since the marginal propensity to consume (MPS) = DS/DDI
    MPS = $1,960/$4,000 = 0.49.
Return to Question 52

53. Output (real GDP) always equals income (Y). If the firm sells the item for $800, then GDP = $800. Since every $ of output produced generates exactly $1 of income, exactly $800, of income is earned, choice d. Specifically, adding the $500 of wages and the $300 of profits yields ($500 + $300) = $800 of income earned, since both wages and profits are considered in determining income.
Return to Question 53

54. The circular flow model tracks money ($) flows. Transfer payments are $ provided by the government to qualifying households. The major transfer payments are social security and medicare benefits (provided to the aged), unemployment compensation, and welfare and medicaid benefits (provided to the poor). The correct choice is e.
Return to Question 54

55.  Unemployment insurance payments represent a government transfer payment. A transfer payment is equivalent to a negative net tax as it is $ paid by the government to the household rather than from the household to the government.
Transfer payments replace part (but not all) of an unemployed worker's lost income. Therefore, if one becomes unemployed, her disposable income will still decrease, but, fortunately, by less than her income decreased because her transfer payments would increase. The correct choice is a.
For example: Assume a worker's income is $10,000 and she pays no taxes and receives no transfer payments. Her disposable income is $10,000.
    From the formula sheet: Disposable Income (DI) = Income (Y) – Taxes + Transfer Payments.
                                        $10,000 = $10,000 - 0 + 0
She loses her job. Her income earned decreases to 0 but she now receives $4,000 of unemployment insurance (a transfer payment). Her disposable income is now reduced not to 0, but to $4,000.
Disposable Income (DI) = Income (Y) – Taxes + Transfer Payments.
$4,000 = 0 - 0 + $4,000
In this example, although her income has decreased by $10,000 (from $10,000 to 0), her disposable income has only decreased by $6,000 (from $10,000 to $4,000) because her government transfer payments have increased from 0 to $4,000.
Return to Question 55

56. A pay cut (a decrease in salary) represents a decrease in one's disposable income earned. As consumption and disposable income are directly (positively) related, a decrease in disposable income would result in a decrease in consumption spending.
    Similarly, saving and disposable income are directly (positively) related, so that a a decrease in disposable income would result in a decrease in saving.
In essence, the marginal propensity to consume (MPC) and marginal propensity to save (MPS) are both positive. The poor not only save less than the rich, the poor also consume less than the rich. As a result, Miss Adams can be expected to decrease both the annual $ amount she consumes (C) and the annual $ amount she saves (S), choice c.
Return to Question 56
57. Gross private domestic investment expenditures (I) in the U.S. is spending by U.S. businesses on new capital goods (plant and equipment) used in production. If a U.S. business purchases a new Gateway computer made in the United States,  the business is investing in a new capital good. The correct choice is c.
Return to Question 57

58. An increase in the economy's level of real GDP represents an increase in production. Businesses will be encouraged to hire labor and increase production when the demand for goods and services increase. An increase in government spending (G), choice c, will serve to stimulate the economy and increase business sales, employment, and production, as businesses supply the increased goods the government demands.
    Note that if the government simultaneously increased net taxes (as indicated in choice e), this increase in taxes would decrease household disposable income and thereby decrease consumption spending by households. This would not be desirable if the economy were in a severe recession, since the tax increase would effectively cancel out the economic stimulation provided by the increase in government spending.
Return to Question 58

59. An increase in government spending (G) represents a direct increase in spending. A reduction in net taxes (T) would increase households' disposable income and result in an increase in consumption spending (C). Both a decrease in taxes and an increase in transfer payments would increase households' disposable income because Disposable Income (DI) = Income (Y) – Taxes + Transfer Payments. If households pay less taxes to the government and receive more transfer payments from the government, then households would have more disposable (after-tax) dollars which they can use for consumption spending.
The correct choice is b. An increase in government spending (G) accompanied by a decrease in taxes and an increase in transfer payments would result in the greatest amount of increased spending.
Return to Question 59

60. A tax cut will increase households' disposable income, thereby increasing their consumption spending. The increased spending on goods and services is shown by an increase in aggregate demand shifting the entire aggregate demand curve to the right.
    If the tax cut encourages labor to work more hours and encourages businesses to invest in new capital goods (as supply-side advocates contend), then the tax cut will succeed in increasing aggregate supply as well as increasing aggregate demand, shifting the entire aggregate supply curve to the right as well.
    A successful supply-side tax cut would therefore cause both the aggregate demand and supply curves to shift to the right, choice b.
Return to Question 60

61. When Mr. Lawrence's disposable income (DI) was $40,000, his consumption spending is also $40,000 since he consumed all of his disposable income.
When his disposable income (DI) is $120,000, his consumption spending is $60,000 (one-half of $120,000).
    We can illustrate these results in a table:
Disposable Income (DI)
Consumption (C)
Saving (S)
$40,000
$40,000
$0
$120,000
$60,000
$60,000 
DDI = $120,000 - $40,000 = $80,000
DC = $60,000 - $40,000  = $20,000
Since the marginal propensity to consume (MPC) = DC/DDI, his MPC = $20,000/$80,000 = 0.25.
Return to Question 61

62. Since a consumption line has consumption spending measured on the vertical axis and disposable income measured on the horizontal axis, the slope of a consumption line is the change in consumption spending (DC) divided by the change in disposable income (DDI). The DC/DDI is the marginal propensity to consume (MPC). As one's disposable income increases, they will both consume more and save more. Since part of the increase in disposable income will be consumed, the MPC is always +. However, since part of the increased in disposable income is saved, the increase in consumption spending will be less than the increase in disposable income. Therefore, although the MPC is always positive, it will also always be less than 1. The correct choice is c.
Return to Question 62

63. Miss Denver's information can be shown by the following table:
Disposable Income (DI)
Consumption (C)
Saving (S)
$10,000
$14,000
- $4,000
$15,000
 >$15,000
 Saving is still negative, but her dissaving is smaller than $4,000.
Note that when Miss Denver's disposable income increased, her consumption increased to above $15,000 since she still dissaves. Since consumption increased as disposable income increased, her marginal propensity to consume (MPC = DC/DDI) is positive.
Also, as her disposable income increased, her saving increased since she reduced her dissaving (smaller negative saving). Since saving increased as disposable income increased, her marginal propensity to save (MPS = DS/DDI) is also positive.
The correct choice is c, both her MPC and MPS are positive.
Return to Question 63

64. Since Saving equals Disposable Income minus Consumption, consumption is $400 less than disposable income when disposable income is $23,000. As shown in row 2 below, consumption is $22,600 when disposable income is $23,000.
Row 1 indicates that when disposable income is $18,000, consumption is also $18,000 since Ms. Vinnick consumes all her disposable income when her disposable income is $18,000.
Disposable Income (DI)
Consumption (C)
Saving (S)
$18,000
$18,000
 
$23,000
$22,600
$400
DDI = $23,000 - $18,000 = $5,000 
DC = $22,600 - $18,000  = $4,600
Since the marginal propensity to consume (MPC) = DC/DDI
    MPC = $4,600/$5,000 = 0.92.
Return to Question 64

65.  [C + I + G +  (X-IM)] is total real expenditures, also called total spending.
C is consumption, I is investment, G is government spending, (X-IM) is net exports (exports - imports).
Since government spending (G) is a component of total spending, a decrease in G would decrease total spending. Less spending represents a decrease in aggregate demand for goods and services. Since the decrease is not caused by an increase in the price level, it is shown by a shift in the entire aggregate demand curve. A decrease in demand is shown by a shift to the left, closer to the origin. The correct choice is b.
Return to Question 65

66. Since Saving equals Disposable Income minus Consumption, consumption is $5,000 more than disposable income when disposable income is $17,000. As shown in row 1 below, consumption is $22,000 when disposable income is $17,000.
Row 2 indicates that when disposable income is $37,000, consumption is $35,400
Disposable Income (DI)
Consumption (C)
Saving (S)
$17,000
$22,000
- $5,000
$37,000
$35,400
 
DDI = $37,000 - $17,000 = $20,000 
DC = $35,400 - $22,000  = $13,400
Since the marginal propensity to consume (MPC) = DC/DDI
    MPC = $13,400/$20,000 = 0.67.
Return to Question 66

67. The greatest resultant  increase in the economy's level of real GDP would be caused by the greatest resultant increase in total spending.
[C + I + G +  (X-IM)] is total real expenditures, also called total spending.
C is consumption, I is investment, G is government spending, (X-IM) is net exports (exports - imports).
An increase in government spending (G) represents a direct increase in total spending.
A decrease in net taxes (T) would increase households' disposable income since Disposable Income (DI) = Income (Y) – Net taxes (T). As disposable income increases, part of the increase will be consumed. This increase in consumption spending (C) will further increase total spending.
Therefore, the combination indicated in choice d, an increase in government spending (G) accompanied by a decrease in net taxes (T) would cause the greatest increase in total spending and, thus, in the economy's level of real GDP.
Note, however, that large increases in total spending, which shift the entire aggregate demand curve to the right, can also result in undesirable inflationary increases in the price level as shown by the shift from point E to N on the graph below:
Graph Question 67 solution
Return to Question 67

68. The receipt of a $200 tax refund would increase each taxpayer's disposable (after-tax) income. Part of any increase in one's disposable income will be consumed (as indicated by the marginal propensity to consume, MPC) and the remaining part of the increase in disposable income will be saved (as indicated by the marginal propensity to save, MPS). Thus, the additional disposable income will increase both the $ amount households consume and the $ amount households save, choice a. The combined increase will be $200, the increase in disposable income.
Return to Question 68

69. Inflation (increases in the nation's price level index) are caused by excess demand for goods and services. This can result from either an increase in demand or a decrease in supply. The largest increase in prices will occur if both of these factors occur. Thus, a shift in the aggregate demand curve to the right (illustrating an increase in demand) combined with a shift in the aggregate supply curve to the left (illustrating a decrease in supply) would result in the largest increase in the nation's price level index. The correct choice is c. This result would be illustrated by the shift from point E to N on the graph below:
Graph Question 69
Return to Question 69

70. When consumers are afraid that prices will rise, they will buy now to beat (before) the price increase. Their buying (increase in demand) will help push up the price, the very thing consumers were afraid would happen. When consumers' actions result in contributing to what they were afraid would occur, this is referred to as a self-fulfilling prophecy, choice b.
Return to Question 70

71. Disposable Income (DI) = Income (Y) – Taxes + Transfer Payments.
An increase in taxes will decrease disposable income.
A decrease in transfer payments (such as unemployment compensation, welfare, and social security benefits) will also decrease disposable income.
Household consumption spending is directly (positively) related to disposable income. If disposable income were to decrease, consumption spending would decrease as a result.
The combination of an increase in taxes accompanied by a decrease in transfer payments, choice b, would cause the largest decrease in disposable income, resulting in the largest decrease in total spending.
Return to Question 71

72. Real Wages = Money Wages/Price level. If the denominator (prices) increase by a smaller percent than the numerator (money wages) increase, then the ratio, real wages, would actually increase, choice e. Real wages represent the purchasing power of one's earnings. As long as a worker's salary (money wages) more than keep pace with inflation (price increases), the worker's real wages (wages adjusted for inflation) would increase.
Return to Question 72

73. To stimulate the economy, the federal government would attempt to increase total spending. The increased spending on goods and services would increase demand for producers' products, thereby encouraging producers to increase production and employment. However, increased spending could contribute to undesirable inflationary price increases. Advocates of supply side economics claim that whereas an increase in government spending would only increase demand (shift the aggregate demand curve to the right), a decrease in taxes would increase both demand and supply (shift both the aggregate demand and aggregate supply curves to the right). Lower taxes would be a preferable policy to increasing government spending because, as shown on the graph below, the shift in the aggregate supply curve, would minimize the inflationary effects of the government stimulative policy.
Graph Question 73 solution
An increase in government spending would only shift the aggregate demand curve to the right. The equilibrium point would change from E to N.
The decrease in taxes (preferred by advocates of supply side economics) will also shift the aggregate supply curve to the right. The equilibrium point would change from E to F. The price level would increase by less than if only the aggregate demand curve shifted to the right.
Return to Question 73

74. Both the MPC and the MPS will have positive values. Since MPC + MPS = 1, then neither the MPC nor the MPS can be greater than 1. If the MPC were greater than 1, then the MPS would have to be a negative number for the formula MPC + MPS = 1 to apply. Therefore, the correct choice is d, it is not possible for the marginal propensity to consume (MPC) to be greater than 1.
Return to Question 74

75. The quantity produced of all goods and services doubles from year 1 to year 2; this indicates that real (constant $) GDP has doubled since real GDP measures any changes in output. However, money GDP is the sum of  P x Q of all goods and services. If quantity (Q) doubled and prices (P) also doubled, then P x Q would be 2 x 2 = 4. Money GDP would have quadrupled (increased four-fold). The correct choice is e.
Return to Question 75

76. Real (Constant $) GDP = (Money GDP/Price Level Index).  If the denominator (prices) remained constant, then the ratio (which represents real GDP) will increase by the exact same percent as the numerator (money GDP) increases; that is, if prices were to remain constant, then any increase  in money GDP (the sum of  P x Q of all goods and services) would be entirely due to an increase in quantity (Q) and would be represented by an equivalent increase in real GDP. The correct choice is c, real GDP increased by the same percentage as money GDP increased.
Return to Question 76

77. When Mr. Jasper's disposable income (DI) was $30,000, his consumption spending is also $30,000 since his saving (S) equaled 0.
When his disposable income (DI) is $80,000, his saving (S) is $20,000 (one-fourth of $80,000). What is not saved is consumed, so his consumption spending is therefore $60,000 ($80,000 of DI - $20,000 of S). We can illustrate these results in a table:
Disposable Income (DI)
Consumption (C)
Saving (S)
$30,000
$30,000
$0
$80,000
$60,000
$20,000 
DDI = $80,000 - $30,000 = $50,000
DC = $60,000 - $30,000  = $30,000
Since the marginal propensity to consume (MPC) = DC/DDI, his MPC = $30,000/$50,000 = 0.60.
Return to Question 77

78. The circular flow of spending, production, and income illustrates how dollars flow throughout the economic system. Expenditures, such as consumption, are shown on the upper flow of the circle and production and income generated by business firm is shown on the lower flow of the circle. The correct answer is income, choice a.
Return to Question 78

79. Real (constant $) GDP is a measurement of the quantity produced of all goods and services. In this example, real GDP has been cut in half.
Money GDP = Price x Quantity. Since prices have doubled and quantity has been cut in half, multiplying two times one-half yields a value of one. So money GDP has remained constant. The correct choice is e.
Return to Question 79

80. A recession occurs when real (constant $) GDP decreases. Real GDP = Money GDP/Price Level. If the numerator, money GDP, increases by a smaller % than the denominator, prices, increase, then real GDP will decrease. The correct choice is b, money GDP increases by 10% while prices increase by 15%.
Return to Question 80

81. A shift up in the entire consumption (C) line occurs when households increase their consumption expenditures at the same level of disposable income; that is, consumption increases and saving decreases by the same amount. This would be caused by an event which increases households' wealth (the value of their assets), enabling households to decrease their saving out of their current income. The correct choice is c, a housing boom increases the value of households' assets (wealth).
Return to Question 81

82. The circular flow model tracks the flow of dollars. When goods are imported into the U.S., U.S. dollars used to pay for these imports flow to Rest of the World. The correct choice is d.
Return to Question 82

83. In the circular flow model, a leakage represents an item which is not directly spent on U.S. goods and services, which leaks out of the expenditure flow. Investment, choice b, does represent spending on capital goods produced in the U.S. This, investment is not considered a leakage in the circular flow model of economic activity.
Return to Question 83

84. As one's disposable income increases, both their consumption spending (C) and saving (S) increase. Mr. Axelrod's disposable income increases by $1,000. His consumption will increase by less than $1,000 and his saving will increase, but also by less than $1,000. Mr. Axelrod's was saving -$1,000 (he was dissaving $1,000). As his disposable income increases by $1,000, his saving will increase, but since it does not increase by the full $1,000, he is still dissaving (although by less than before). His saving will now be between -$1,000 and 0, choice d.
For example, if Mr. Axelrod's saving increased by $400 (and his consumption increased by $600) of the additional $1,000 of disposable income, his new level of saving would by -$1,000 + $400 = -$600 (an amount between -$1,000 and 0). His dissaving would be reduced, but not entirely eliminated.
Return to Question 84

85. So as to protect elderly social security recipients from the harmful effects of inflation, the government guarantees retirees a fixed real (in terms of purchasing power) social security check. Thus, if, during one's retirement years, inflationary price increases go over 3% per year, the retirees' social security check from the government will also go up by 3%. The correct choice is b.
Return to Question 85

86. When Ms. Tuttle's disposable income (DI) was $30,000, her saving is $7,500, one-fourth of her disposable income.
When her disposable income (DI) increased to  $80,000, her saving increased to $40,000 (one-half of $80,000). What is not saved is consumed, so her consumption spending  therefore increased from $22,500 ($30,000 - $7,500) to $40,000 ($80,000 of DI - $40,000 of S). We can illustrate these results in a table:
Disposable Income (DI)
Consumption (C)
Saving (S)
$30,000
$22,500
$7,500
$80,000
$40,000
$40,000 
DDI = $80,000 - $30,000 = $50,000
DC = $40,000 - $22,500  = $17,500
Since the marginal propensity to consume (MPC) = DC/DDI, her MPC = $17,500/$50,000 = 0.35.
Return to Question 86

87. Real GDP = Money GDP/Price Level. Since money GDP (the numerator) increased by a larger percent than prices (the denominator) increased, real GDP must have increased. However, since prices did increase, the increase in real GDP will be less than the increase in money GDP. Only if there were no inflationary price increase (no increase in the denominator) would real GDP be able to increase by the same percent as money GDP increased. The correct choice is a, real (constant $) GDP increased by a smaller percent than money GDP increased.
Return to Question 87

88. A housing boom increases the value of households' assets (wealth). This would be illustrated by a shift up in the entire consumption line. This increase in wealth would enable households to decrease their saving out of their current disposable income, thereby increasing their consumption spending by an equal amount.
For example, if one's disposable income remained constant and they increased their consumption spending by $3,000, they would be saving $3,000 less of their disposable income. When households notice that the value of their house increases, they can afford to save less of their current income because they have the option of selling their higher valued house to provide for their retirement needs.
    The correct choice is c.
Return to Question 88

89. The upper flow of the circular flow model of economic activity illustrates the spending flows. These $ flows go toward the business sector. The major component of spending is consumption, choice b. Consumption spending by households flows from the household sector on the left to the business sector on the right.
Return to Question 89

90. If the economy is experiencing a severe inflation, then appropriate government policy is to decrease spending. The decrease in spending will help slow down the inflationary price increases. Government can either decrease its own spending or decrease private household spending. An increase in net taxes on households will decrease households' disposable (after-tax) income, thereby decreasing households' ability to spend.
    The most appropriate government fiscal policy to cure the inflationary problem is choice b, government decreases spending and simultaneously increases net taxes.
Return to Question 90

91. When consumers are afraid that prices will rise, they will buy now to beat (before) the price increase. This act of households consuming more of their current income (and saving less) is illustrated by a shift up in the entire consumption (C) line, choice a. Note that this would be a shift up in the entire consumption line because households are consuming more of their existing, current income. If the increased consumption spending had been due to an increase in household income, then this would have been illustrated by a movement up and to the right along a given consumption line.
Return to Question 91

92. When Ms. London's disposable income (DI) was $40,000, her consumption spending is also $40,000 since she consumed 100% of her disposable income. Her saving is therefore 0.
    When her disposable income (DI) increased to $60,000, her consumption is $45,000 (three-fourth of $60,000). Saving (S) = DI – C. Her saving is therefore $60,000 - $45,000 = $15,000. We can illustrate these results in a table:
Disposable Income (DI)
Consumption (C)
Saving (S)
$40,000
$40,000
$0
$60,000
$45,000
$15,000 
DDI = $60,000 - $40,000 = $20,000
 
DS = $15,000 - $0  = $15,000
Since the marginal propensity to save (MPS) = DS/DDI, her MPS = $15,000/$20,000 = 0.75.
Return to Question 92

93. Real GDP = Money GDP/Price Level. Since prices (the denominator) increased, for real GDP to increase, the numerator (money GDP) must have increased by more than prices increased.
    If prices would have remained constant, then real GDP and money GDP would have increased by the same percent; however, in this example, prices (the denominator) increased. Therefore, real GDP (the entire ratio) would not increase by as large a percent as money GDP (the numerator)  increased.
    The correct answer is d. Money GDP increased by a larger percent than both real (constant $) GDP and prices increased.
Return to Question 93

94. The marginal propensity to consume (MPC) is a positive value less than 1. If one's disposable income were to increase by $1,000, part of the additional $1,000 would be consumed and part would be saved. Therefore, Mr. Durkin's consumption would increase, but by less than $1,000. Since he was consuming $21,000, we would expect his consumption spending now to be between $21,000 and $22,000, choice d.
Return to Question 94


95.
Graph Question 95
The change from A to B illustrates a shift down in the entire consumption line. This represents a decrease in consumption spending caused by something other than a decrease in one's disposable income; that is, less consumption at the same level of disposable income. A fall in consumer confidence when households become pessimistic about the economy's future will cause consumers to become more cautious and reduce their consumption (and increase their saving) out of their current disposable income. The correct choice is d.
Return to Question 95


96. Since Saving equals Disposable Income minus Consumption, we can determine one's saving by computing consumption and subtracting that amount from disposable income.
DC = MPC x  DDI. The MPC is equal to 0.74 in this problem.
As DI increases by $7,000  (from $50,000  to $57,000 ), DC = 0.74 x $7,000  = $5,180 .
The amount of consumption spending is shown in the table below in column 2.
Since S = DI - C, the amount of saving (S) at a disposable income level of $57,000  is calculated on the last row in column 3:
Disposable Income (DI)
Consumption (C)
Saving (S)
$50,000 
$45,000 
DDI. = $7,000 
DC = $5,180 
 
$57,000 
$45,000  + $5,180  = $50,180 
$57,000  - $50,180 = $6,820
Return to Question 96


97. Real GDP = Money GDP/Price Level.  Real GDP would decrease if money GDP (the numerator) increases by less than the price level (the denominator) increases. Real GDP would also decrease if money GDP (the numerator) decreases by more than the price level (the denominator) decreases. Since none of the choices describes either of these conditions, the correct choice is f, none would result in a decrease in real (constant $) GDP.
Return to Question 97


98. When the production of goods and services, as measured by real GDP, decreases, fewer workers are needed and unemployment increases. As shown on the graph below, real GDP will suffer the largest decrease when both the aggregate demand and aggregate supply curves shift to the left. The result is a shift from point E to point N. The correct choice is a.
Graph Question 98
Return to Question 98


99. Real GDP = Money GDP/Price Level. Since real GDP increased, then the price level (the denominator) could not have increased by more than money GDP (the numerator) increased. Also, if the price level were to decrease, then real GDP would increase by more than money GDP increased. Since money GDP increased by a larger percent than real GDP increased, the price level could not have decreased. Therefore, the price level must have increased by less than money GDP increased. This would enable real GDP to still increase, but the increase in the price level prevents real GDP from increasing as much as money GDP. The correct choice is d.
Return to Question 99


100. If Ms. Burton is consuming all her $50,000 of disposable income, she is saving 0. Her disposable income then decreases by $5,000 from $50,000 to $45,000. Both the marginal propensity to consume (MPC) and marginal propensity to save (MPS) are positive and less than 1. This means that as one's disposable income decreases, both consumption and saving will decrease. Each will decrease by part of the $5,000 decrease in disposable income. Therefore, the decrease in saving will be smaller than $5,000. The result is that the level of Ms. Burton's saving will now be between -$5,000 and $0, choice b.
Return to Question 100


101.
Graph Question 101
The change from E to N is created by a shift in the aggregate supply curve up and to the left accompanied by a shift in the aggregate demand curve up and to the right. An increase in oil prices would increase the cost of production and shift the aggregate supply curve up and to the left (referred to as a decrease in supply). An increase in overall consumption spending by households would shift the aggregate demand curve up and to the right (referred to as an increase in demand). The correct choice is b.
Return to Question 101


102. By returning $600 to taxpayers, a tax rebate represents a reduction in one's net taxes. Since Disposable Income (DI) = Income (Y) – Net taxes (T), reducing net taxes will increase the disposable (after-tax) income of households. The positively sloped consumption line illustrates the direct relationship between consumption spending (measured on the y-axis) and disposable income (measured on the x-axis). If disposable income increases, then consumption spending would increase. This is shown by a movement up and to the right along a given consumption line, choice a.
Return to Question 102


103. Money GDP = price (P) x quantity (Q) of all goods and services produced. If price doubles and quantity produced is cut in half, then money GDP remains constant because 2 x 1/2 = 1.
    Real(constant $)  GDP = Money GDP/Prices. Since Money GDP remains constant and prices doubled, then 1/2 indicates that real GDP is cut in half.
The correct choice is c.
Return to Question 103


104. If the federal government's economic bailout measures increase consumer confidence, this will reduce household fears of becoming unemployed. This will generate more consumption spending  since households will not feel the necessity to save as much as protection against impending unemployment. The entire consumption line will shift up as consumption spending increases out of a given disposable income. If more jobs are in fact created, then this will increase disposable income, enabling households to further increase their consumption spending. This increase in consumption spending out of additional disposable income is shown by a movement up and to the right along the new positively sloped consumption line. The correct choice is c.
Return to Question 104


105. Deflation, a decrease in the nation's overall price level, increases the value (purchasing power) of the dollar. This especially hurts debtors (borrowers) because the purchasing power of each dollar they are forced to repay to their lenders has increased. Essentially, even though their debt is the same in dollar terms, the real value of the debt has increased. The correct choice is b.
Return to Question 105


106. When consumer confidence is low, households fear that they may lose their jobs and incomes in the near future. As a result, caution dictates that they save more now while they still have a job. The only way to increase one's saving out of their disposable income is to decrease their consumption spending. Every dollar less spent represents an additional dollar saved. The result will be a shift down in households' consumption line with households decreasing the $ amount they consume, but increasing the $ amount they save, choice c.
Return to Question 106


107. If Ms. Bronson's disposable income is $44,000 and she is saving $4,000, then she is currently consuming $40,000. If her disposable income were to decrease because of a salary cut, both her consumption and saving would decrease. Since her disposable income decreases by $4,000, her consumption spending will decrease, but the decrease in consumption spending will be less than $4,000 because she will also decrease her saving. The result is that although her consumption spending will be less than the original $40,000, since consumption did not decrease by the full $4,000 decrease in disposable income, consumption spending will be greater than $36,000. The correct choice is b, consumption spending will be between $36,000 and $40,000.
Return to Question 107


Return to top of page