Consider two closed economies that are identical except for their marginal propensity to consume (MPC). Each economy is currently in equilibrium with real GDP and total expenditure equal to $100 billion, as shown by the black points on the following two graphs. Neither economy has taxes that change with income. The grey lines show the 45-degree line on each graph.The first economy's MPC is 0.5. Therefore, its initial total expenditure line has a slope of 0.5 and passes through the point (100, 100).The second economy's MPC is 0.70. Therefore, its initial total expenditure line has a slope of 0.70 and passes through the point (100, 100).Now, suppose there is an increase of $30 billion in investment in each economy.Place a green line (triangle symbol) on each of the previous graphs to indicate the new total expenditure line for each economy. Then place a black point (plus symbol) on each graph showing the new level of equilibrium output. (Hint: You can see the slope and vertical axis intercept of a line on the graph by selecting it.) In the first economy (with MPC = 0.5), the $30 billion increase in investment causes equilibrium output to increase by (fill in the blank) billion. In the second economy (with MPC = 0.70), the $30 billion increase in investment causes equilibrium output to increase by (fill in the blank) billion. Therefore, a higher MPC is associated with a (higher or lower) multiplier. Now, confirm your graphical analysis algebraically using the oversimplified multiplier formula:Multiplier = 1/(1-MPC) For the first economy, with an MPC of 0.5, the effect of the $30 billion increase in investment is as follows:Change in equilibrium output =Change in Total ExpenditureChange in Total Expenditure × Multiplier = (+30 billion, -30 billion, +60 billion, or -60 billion) ×1/(1-0.70) OR 1/(1-0.50) OR 1(1-0.70) OR 1(1-0.50) = (+30 billion, -30 billion, +60 billion, or -60 billion) ×(Fill in the blank) = (+30 billion, -30 billion, +60 billion, or -60 billion) × Using the same method, the multiplier for the second economy is (0.59, 2, 0.3, 0.70, or 3.33). **Graph Description: Equilibrium in Aggregate Expenditure Model**This graph illustrates the concept of equilibrium in the Aggregate Expenditure model. - **Axes**: - The horizontal axis represents "Real GDP" in billions of dollars. - The vertical axis represents "Total Expenditure" in billions of dollars.- **Lines**: - **45-Degree Line**: This line represents points where total production (GDP) equals total spending. - **AE Line**: The original Aggregate Expenditure line, indicating planned expenditures at different levels of GDP. - **New AE Line**: A hypothetical new Aggregate Expenditure line that would occur due to a change in economic conditions.- **Markers**: - **New Equilibrium**: Denoted by a plus symbol (+), marking the intersection of the New AE Line and the 45-Degree Line.- **Parameter**: - The graph shows the Marginal Propensity to Consume (MPC) as 0.5, which influences the slope of the AE line.**Interpretation**:The equilibrium occurs where the AE Line intersects the 45-Degree Line, meaning the economy is in balance, with no unintended inventory accumulation. Changes in the AE Line, shown here by the New AE Line, adjust the point of equilibrium, reflecting changes in spending behavior or economic conditions. The image displays a graph illustrating the relationship between Real GDP (Billions of dollars) on the horizontal axis and Total Expenditure (Billions of dollars) on the vertical axis. The graph includes a 45-degree line, a blue line labeled "AE Line," and another green line labeled "New AE Line."1. **45-Degree Line**: This line represents points where Total Expenditure equals Real GDP, indicating equilibrium.2. **AE Line**: The blue line shows the current aggregate expenditure line with the marginal propensity to consume (MPC) set at 0.70. This line intersects the vertical and horizontal axes at lower points compared to the new AE line.3. **New AE Line**: The green line indicates the aggregate expenditure line after a change, leading to a new equilibrium point, marked by a cross.4. **New Equilibrium**: Represented by a black cross, this point indicates the intersection of the new AE Line with the 45-degree line, signifying a shift in equilibrium due to changes in economic variables.The graph effectively demonstrates how changes in investment can impact equilibrium output, with adjustments visible through shifts in the AE lines and equilibrium points.Below the graph, the text explains that in an economy with an MPC of 0.70, a $30 billion increase in investment leads to a specific change in equilibrium output. The graph visually supports this concept, showing the shift from the original AE Line to the New AE Line, moving the equilibrium point accordingly.

Aggregate demand, in economics, refers to the total amount of final goods and services demanded in…

Answered: Consider two closed economies that are…

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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Consider two closed economies that are identical except for their marginal propensity to consume (MPC). Each economy is currently in equilibrium with real GDP and total expenditure equal to $100 billion, as shown by the black points on the following two graphs. Neither economy has taxes that change with income. The grey lines show the 45-degree line on each graph.

The first economy's MPC is 0.5. Therefore, its initial total expenditure line has a slope of 0.5 and passes through the point (100, 100).

The second economy's MPC is 0.70. Therefore, its initial total expenditure line has a slope of 0.70 and passes through the point (100, 100).

Now, suppose there is an increase of $30 billion in investment in each economy.

Place a green line (triangle symbol) on each of the previous graphs to indicate the new total expenditure line for each economy. Then place a black point (plus symbol) on each graph showing the new level of equilibrium output. (Hint: You can see the slope and vertical axis intercept of a line on the graph by selecting it.)

In the first economy (with MPC = 0.5), the $30 billion increase in investment causes equilibrium output to increase by (fill in the blank) billion. In the second economy (with MPC = 0.70), the $30 billion increase in investment causes equilibrium output to increase by (fill in the blank) billion. Therefore, a higher MPC is associated with a (higher or lower) multiplier.

Now, confirm your graphical analysis algebraically using the oversimplified multiplier formula:

Multiplier = 1/(1-MPC)

For the first economy, with an MPC of 0.5, the effect of the $30 billion increase in investment is as follows:

Change in equilibrium output	=	Change in Total ExpenditureChange in Total Expenditure ×	Multiplier
	=	(+30 billion, -30 billion, +60 billion, or -60 billion) ×	1/(1-0.70) OR 1/(1-0.50) OR 1(1-0.70) OR 1(1-0.50)
	=	(+30 billion, -30 billion, +60 billion, or -60 billion) ×	(Fill in the blank)
	=	(+30 billion, -30 billion, +60 billion, or -60 billion) ×

Using the same method, the multiplier for the second economy is (0.59, 2, 0.3, 0.70, or 3.33).

**Graph Description: Equilibrium in Aggregate Expenditure Model**

This graph illustrates the concept of equilibrium in the Aggregate Expenditure model.

- **Axes**:
- The horizontal axis represents "Real GDP" in billions of dollars.
- The vertical axis represents "Total Expenditure" in billions of dollars.

- **Lines**:
- **45-Degree Line**: This line represents points where total production (GDP) equals total spending.
- **AE Line**: The original Aggregate Expenditure line, indicating planned expenditures at different levels of GDP.
- **New AE Line**: A hypothetical new Aggregate Expenditure line that would occur due to a change in economic conditions.

- **Markers**:
- **New Equilibrium**: Denoted by a plus symbol (+), marking the intersection of the New AE Line and the 45-Degree Line.

- **Parameter**:
- The graph shows the Marginal Propensity to Consume (MPC) as 0.5, which influences the slope of the AE line.

**Interpretation**:
The equilibrium occurs where the AE Line intersects the 45-Degree Line, meaning the economy is in balance, with no unintended inventory accumulation. Changes in the AE Line, shown here by the New AE Line, adjust the point of equilibrium, reflecting changes in spending behavior or economic conditions.

The image displays a graph illustrating the relationship between Real GDP (Billions of dollars) on the horizontal axis and Total Expenditure (Billions of dollars) on the vertical axis. The graph includes a 45-degree line, a blue line labeled "AE Line," and another green line labeled "New AE Line."

1. **45-Degree Line**: This line represents points where Total Expenditure equals Real GDP, indicating equilibrium.

2. **AE Line**: The blue line shows the current aggregate expenditure line with the marginal propensity to consume (MPC) set at 0.70. This line intersects the vertical and horizontal axes at lower points compared to the new AE line.

3. **New AE Line**: The green line indicates the aggregate expenditure line after a change, leading to a new equilibrium point, marked by a cross.

4. **New Equilibrium**: Represented by a black cross, this point indicates the intersection of the new AE Line with the 45-degree line, signifying a shift in equilibrium due to changes in economic variables.

The graph effectively demonstrates how changes in investment can impact equilibrium output, with adjustments visible through shifts in the AE lines and equilibrium points.

Below the graph, the text explains that in an economy with an MPC of 0.70, a $30 billion increase in investment leads to a specific change in equilibrium output. The graph visually supports this concept, showing the shift from the original AE Line to the New AE Line, moving the equilibrium point accordingly.

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