What is the expression for government spending multiplier



1. Based on your understanding of the aggregate expenditure model, we know with certainty that an equal and simultaneous increase in G and T will cause:

(a) an increase in output

(b) no change in output

(c) a reduction in output

(d) an increase in investment

(e) a decrease in investment

For the following two questions, suppose an economy produces only milk and butter. Assume that all production is consumed in each year, and that price and quantity data are given in the tables below.

           Year 1
Good   Quantity   Price 
Milk       500        $2
Butter   2000       $1

           Year 2
Good   Quantity   Price
Milk       900        $3
Butter   3000       $2

2. (Refer to the above tables) Between Year 1 and Year 2, real GDP (based on Year 1 as a base year) grew by

(a) 58.18%

(b) 158.18%

(c) 160%

(d) 60%

(e) 260%

3. (Refer to the above tables) Between Year 1 and Year 2, the GDP deflator (based on Year 1 as a base year) rose

(a) 81.25%

(b) 90%

(c) 190%

(d) 83.33

(e) 183.33%

4. Which of the following generally occurs when a central bank pursues expansionary monetary policy?

(a) the central bank purchases bonds and the interest rate increases

(b) the central bank purchases bonds and the interest rate decreases

(c) the central bank sells bonds and the interest rate increases

(d) the central bank sells bonds and the interest rate decreases

(e) an increase in the reserve requirement ratio

5. The marginal propensity to consume represents

(a) the level of consumption that occurs if disposable income is zero.

(b) the ratio of total consumption to disposable income.

(c) total income minus total taxes.

(d) the change in output caused by a one-unit change in autonomous demand.

(e) the change in consumption caused by a one-unit change in disposable income.

6. Suppose a one-year discount bond offers to pay $1000 in one year and currently has a 15% interest rate. Given this information, we know that the bond's price must be approximately:

(a) $870

(b) $1150

(c) $850

(d) $950

(e) $985

7. Equilibrium in the goods market requires that

(a) production equals income.

(b) production equals demand.

(c) consumption equals saving.

(d) consumption equals income.

(e) government spending equals taxes minus transfers.

8. The LM curve shifts down when which of the following occurs?

(a) an increase in taxes

(b) an increase in output

(c) an open market purchase of bonds by the central bank

(d) a decrease in the nominal money stock

(e) an increase in the price level

9. Suppose there is an increase in consumer confidence. Which of the following represents the complete list of variables that must increase in the short run in response to this increase in consumer confidence?

(a) consumption

(b) consumption and investment

(c) consumption, investment and output

(d) consumption and output

(e) consumption, output and the interest rate

10. In a given year, suppose a company spends $100 million on intermediate goods and $200 million on wages, with no other expenses. Also assume that its total sales are $800 million.

The value added by this company equals:

(a) $200 million

(b) $300 million

(c) $500 million

(d) $700 million

(e) $800 million


1. Consider an economy with a corn producer, some consumers, and a government. In a given year, the corn producer grows 30 million bushels of corn and the market price for corn is $5 per bushel. Of the 30 million bushels produced, 20 million bushels are sold to consumers, 5 million are stored in inventory, and 5 million are sold to the government to feed the army.

The corn producer pays $60 million in wages to consumers and $10 million in taxes to the government. Consumers pay $5 million in taxes to the government, and receive $5 million in Social Security payments from the government. The profits of the corn producer are distributed to consumers. Calculate private disposable income, private sector saving, government saving, (national) saving, and the government deficit.

2. Assume an economy with a coal producer, a steel producer, and some consumers (there is no government). In a given year, the coal producer produces 15 million tons of coal and sells it for $5 per ton. The coal producer pays $50 million in wages to consumers. The steel producer uses 25 million tons of coal as an input into steel production, all purchased at $5 per ton. Of this, 15 million tons of coal comes from the domestic coal producer and 10 million tons is imported. The steel producer produces 10 million tons of steel and sells it for $20 per ton. Domestic consumers buy 8 million tons of steel, and 2 million tons are exported. The steel producer pays consumers $40 million in wages. All profits made by domestic producers are distributed to domestic consumers.

Show the details of the calculations that determine GDP using the

(a) product (value-added) approach,

(b) expenditure (value of final goods) approach,

(c) and income approach.

3. Consider the following economy.

Y = Z

Z = C + I + G

C = c0 + c1YD

YD = Y - T

T = t0 + t1Y

I = b0

G = g0

where Y is output, Z is aggregate demand, C is consumption, I is investment, G is government spending, YD is disposable income, T is a tax function, t0 is a lump-sum tax, t1 is a proportional tax on income, and I is investment. The parameter values are c0 = 1000, c1 = 0.75, t0 = -600, t1 = 0.2, b0 = 800, and g0 = 1200.

(a) Solve for an expression for equilibrium Y (i.e., keeping all algebraic symbols), then calculate equilibrium Y using the expression and the parameter values.

(b) Graph the aggregate expenditure/goods market model. Be sure to indicate the numerical values of the intercept and slope of the demand curve as well as the value where the demand curve crosses the 45 degree line. Why is the slope different than the marginal propensity to consume out of income?

(c) What is the expression for the government spending multiplier? What is the expression for the lump-sum tax multiplier? What are the values of these multipliers? Why does a reduction in lump-sum taxes have a different size multiplier than an increase in government spending?

(d) Suppose G = g1 = 1500 in the following year, but everything else remains the same.

What is next year's equilibrium Y? Call this equilibrium Y1, and the old equilibrium Y0. What is the percent change in equilibrium output year-over-year? Draw the new demand curve on the same figure as item (b) and indicate the relevant values. Indicate with an arrow the direction the demand curve shifts.

4. Suppose that money demand is given by

Md = $Y (.25 - i)

where $Y is $100. Also suppose that the supply of money is $20.

(a) What is the equilibrium interest rate?

(b) If the Federal Reserve wants to increase i by 10 percentage points (e.g., from 2% to 12%), at what level should it set the supply of money?

5. Show the changes on short run equilibrium real GDP and the equilibrium nominal interest rate in the IS-LM model from each of the following policies/economic situations. Briefly explain any economic reactions (i.e. what is occurring in the goods and/or money markets.

One graph is necessary for each part. Clearly label your graph for full credit.

(a) A decrease in taxes

(b) An increase in the money supply

(c) A decrease in consumer confidence

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