## Review Questions for Chapter 27

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1.    If the full employment level of real GDP (Y) is \$6,300 billion, the equilibrium level of real GDP (Y) is \$6,000 billion, and the MPC is 0.80, then an appropriate increase in government spending (G) to move the economy to full employment would be  (Round off your answer to the nearest billion dollar, if necessary)

2. Assume the marginal propensity to consume (MPC) = 0.60. If the economy has a recessionary gap of \$50 billion, then to eliminate the gap the government should increase government spending (G) by (Round off your answer to the nearest billion dollar, if necessary)
3.    If the marginal propensity to consume (MPC) were equal to 0.80 and government spending (G) increases by \$25 billion, the resultant change in the economy's equilibrium level of real GDP (Y) will be a change of (Round off your answer to the nearest billion dollar, if necessary)
4.    Assume that the marginal propensity to consume (MPC) = 0.80. If the economy has a recessionary gap of \$40 billion, then to eliminate the gap there would have to be an increase in investment (I) of (Round off your answer to the nearest billion dollar, if necessary)
5. The lower the value of the marginal propensity to consume (MPC), then the
1. larger is the multiplier and the greater is the effect a given change in government spending (G) would have on the economy's equilibrium level of  real GDP (Y).
2. larger is the multiplier and the smaller is the effect a given change in government spending (G) would have on the economy's equilibrium level of  real GDP (Y).
3. smaller is the multiplier and the greater is the effect a given change in government spending (G) would have on the economy's equilibrium level of  real GDP (Y).
4. smaller is the multiplier and the smaller is the effect a given change in government spending (G) would have on the economy's equilibrium level of  real GDP (Y).

6. The economy's equilibrium level of real GDP (Y) is \$5,700 billion. Government spending (G) then decreases. As a result, the equilibrium level of real GDP (Y) decreases to \$5,200 billion. If the marginal propensity to consume (MPC) = 0.90, then by how much must government spending (G) have decreased? (Round off your answer to the nearest billion dollar, if necessary)
7. If the marginal propensity to consume (MPC) were equal to 0.98 and investment (I) increases by \$13 billion, then the resultant change in the economy's equilibrium level of real GDP (Y) will be (Round off your answer to the nearest billion dollar, if necessary)
8. The economy's equilibrium level of real GDP (Y) is \$5,000 billion. The government wants to change its spending (G) so that the equilibrium level of real GDP (Y) will increase to \$5,460 billion. If the MPC = 0.75, then by how much must government spending (G) be changed? (Round off your answer to the nearest billion dollar, if necessary)
9. A decrease in investment (I) of 25 will cause a shift in the entire real expenditure [C+I+G+(X-IM)] line
1. up by: 25 X multiplier.
2. up by: MPC X 25.
3. up by: MPC X 25 X multiplier.
4. down by: 25.
5. down by: MPC X 25.
6. down by: 25 X multiplier.

10.    The economy's equilibrium level of real GDP (Y) is \$5,000 billion. Investment (I) then changes because of President Clinton's business tax incentives. As a result, the equilibrium level of real GDP (Y) increases to \$5,400 billion. If the MPC = 0.80, then by how much must investment (I) have changed? (Round off your answer to the nearest billion dollar, if necessary)
11. Assume that businesses increase their investment spending (I) by \$100 million. The larger the value of the marginal propensity to consume (MPC), the
1. greater will be the value of the multiplier and the greater will be the resultant change in real GDP (Y).
2. greater will be the value of the multiplier and the smaller will be the resultant change in real GDP (Y).
3. smaller will be the value of the multiplier and the greater will be the resultant change in real GDP (Y).
4. smaller will be the value of the multiplier and the smaller will be the resultant change in real GDP (Y).

12. An increase in government spending (G) of \$100 will cause a shift in the entire real expenditure [C+I+G+(X-IM)] line
1. up by: \$100 X multiplier.
2. up by: MPC X \$100.
3. up by: MPC X \$100 X multiplier.
4. down by: \$100 X multiplier.
5. down by: MPC X \$100.
6. None of the above answers is correct.

Review Questions from Last Year's Exams

13.  The government increases spending (G) by 100. The larger the marginal propensity to consume (MPC) that exists in the economy,

1. the smaller the multiplier and the larger the resultant change in real GDP (Y) that will occur.
2. the smaller the multiplier and the smaller the resultant change in real GDP (Y) that will occur.
3. the larger the multiplier and the larger the resultant change in real GDP (Y) that will occur.
4. the larger the multiplier and the smaller the resultant change in real GDP (Y) that will occur.

14. If the full employment level of real GDP (Y) is \$9,000 billion, the equilibrium level of real GDP (Y) is \$8,000 billion, and the MPC is 0.75, then an appropriate increase in government spending (G) to move the economy to full employment would be  (Round off your answer to the nearest billion dollar, if necessary)

15. Assume the marginal propensity to consume (MPC) = 0.75. If the economy has a recessionary gap of \$200 billion, then to eliminate the gap the government should increase government spending (G) by (Round off your answer to the nearest billion dollar, if necessary)

16. If the marginal propensity to consume (MPC) were equal to 0.95 and investment expenditures (I) increase by \$23 billion, then the resultant change in the economy's equilibrium level of real GDP (Y) will be (Round off your answer to the nearest billion dollar, if necessary)

17. Assume the economy’s marginal propensity to consume (MPC) = 0.85 and there are no taxes. Workers in industry X receive a salary increase of \$500,000. They devote all their additional consumption expenditures (C) on clothing. As a result, what will be the \$ increase in consumption expenditures (C) by the income earners in the clothing industry?

## Formulas

Output (GDP) always equals income (Y).

Disposable Income (DI) = Income (Y) – Net taxes (T)
[Net Taxes (T) = Taxes - Transfer Payments]

Saving (S) = DI - C    (S is saving, DI is disposable income, C is consumption)

MPC = DC/DDI        (MPC is the marginal propensity to consume)

DC = MPC x  DDI

MPS = DS/DDI         (MPS is the marginal propensity to save)

DS = MPS x DDI

MPC + MPS = 1

MPS = 1 - MPC

[C + I + G + (X-IM)] = Y is the equilibrium condition.

[C + I + G +  (X-IM)] is total real expenditures
C is consumption, I is investment, G is government spending, (X-IM) is net exports (exports - imports).

Inventory Change (Iu) = Y - [C + I + G +  (X-IM)]

Recessionary Gap = Amount by which full employment real GDP (Y) exceeds the equilibrium level of real GDP (Y).

Inflationary Gap = Amount by which full employment real GDP (Y) is less than the equilibrium level of real GDP (Y).

Multiplier = 1/(1-MPC)  or   1/MPS

Resultant D in Y = Initial D in total real expenditures [C,I,(X-IM) or G] x multiplier

Solution to Q1

Solution to Q2

Solution to Q3

Solution to Q4

Solution to Q6

Solution to Q7

Solution to Q8

Solution to Q10

Solution to Q14