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.
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.
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.
Transcribed Image Text: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 eqguilibrium output. (Hint: You can see the slope and vertical axis intercept of a line on the graph
by selecting it.)
(?
(?
МРС-0.5
MPC=0.70
200
45-Degree Line
45-Degree Line
200
180
180
New AE Line
New AE Line
180
160
140
140
120
New Equilibrium
120
New Equilibrium
100
100
80
80
AE Line
40
AE Line
20
20
40
60
80
100
120
140
160
180 200
20
40
60
80
100
120
140
180
180
200
REAL GDP (Billions of dollars)
REAL GDP (Billions of dollars)
In the first economy (with MPC = 0.5), the $30 billion increase in investment causes equilibrium output to increase by $
billion. In the
second economy (with MPC = 0.70), the $30 billion increase in investment causes equilibrium output to increase by $
billion. Therefore, a
higher MPC is associated with a
v multiplier.
higher or lower?
Now, confirm your graphical analysis algebraically using the oversimplified multiplier formula:
Multiplier =
For the first economy, with an MPC of 0.5, the effect of the $30 billion increase in investment is as follows:
multiplier options:
Change in Equilibrium Output = Change in Total Erpenditure x Multiplier
1x (1– 0.70)
1-0,70
1 (1– 0.5)
Using the same method, the multiplier for the second economy is
choices: (0.70, 2 , 0.3, 0.59,
3.33)
Change in Total
Expenditure choices:
+$60 billion
-$30 billion
+$30 billion
-$60 billion
TOTAL EXPENDITURE (Billions of dollars)
TOTAL EXPENDITURE (Billions of dollars)
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