Using an appropriately labeled
money market graph, show the
effects of an open market
purchase of government securities
by the FED on :
• The money supply
• Interest rates
Nominal
Interest
rates
Sm1 Sm2
i1
i2
Dm
Qm1 Qm2
Q of Money
Use ½ of your board for each bullet below:
• Assume the economy is currently at full employment.
Using an appropriately labeled AD-AS model show the
short-run effects of an open-market sale of
government securities by the FED on the following:
– Price level
– Real output
• On an appropriately labeled graph of the Phillips
Curve,
Curve show how the open-market operation will
affect the following in the short run. Use an arrow to
show direction of change.
– Unemployment rate
– Inflation rate
9 Identify a fiscal policy action that would offset the
impact on real output and price level identified on the
AD-AS model.
AD-AS Model
PL
LRAS
SRAS
The Phillips Curve
Inflation
rate
%1
PL1
PL2
%2
AD2
Y2 YF
AD1
GDPR
SRPC
U1
U2
Unemployment rate
The initial open market operation sale of government securities
decreased the money supply and increased interest rates. The
increase in interest rates decreased C and I causing AE and AD to
decline. The decrease in AD reduced the PL and output. The Phillips
curve shows the trade-off between inflation and unemployment in the
long-run – as the rate of inflation dropped, unemployment increased.
A fiscal policy action to address the recession caused by the OMO is
increase G or decrease T or both.
The Spending Multiplier
What effect does a change in
spending (AE) have on income and
output in the economy?
small changes in spending → _______
greater changes in income/output
_______
Key Ideas and Concepts
•
•
•
•
•
•
APC Average Propensity to Consume = C/Yd
APS Average Propensity to Save =
S/Yd
MPC Marginal Propensity to Consume =ΔC/ ΔYd
=ΔS/ ΔYd
MPS Marginal Propensity to Save
1/MPS
1/1-MPC
ΔGDP/ ΔAE
M = _________
or _________
or _________
ΔGDPe = __ Δ AE___ x ___Multiplier____
Δ G vs. ΔT: impact?
• Assume MPC of .75, what is the impact on
GDPe of a $100 billion increase in G?
ΔGDPe = ΔAE x M = 100 x 4 = 400
M = 1/1-.75 = 1/.25 = 4
• What is the impact if government lowers T
by $100 billion instead of increasing G?
↓T →↑YD of $100 B →
↑ΔC = .75(100) = 75B →
75 x 4 = ↑300B
What happens to the federal budget
(ceteris paribus) in each of the following
situations:
• ↑ G by $50B ↓ T by $100B
• ↓ taxes by $100 billion
• ↓ G by $40B ↑ Taxes by $50B
• ↑G by $25B ↑ taxes by $25B
• ↓G by $30B ↓ taxes by $30B
Deficit of 150B
Deficit of 100B
Surplus of 90B
NC balanced Budg.
NC balanced Budg.
Balanced Budget Multiplier = 1
1 x ΔG = 1 x 100 = ↑100B
• What is the impact of equal increases in G
and T of $100 if the MPS =.20?
ΔAE x M = 100 x 5 = ↑ 500 B
M = 1/.20 = 5
↑T 100 B →↓100 B in YD → ↓ C = .80(100)=80 B
ΔAE x M =80 x 5 = ↓400 B
Therefore, net effect on the economy is ↑100B.
100B
AP Questions
The Multiplier
If $500 billion in AE → $1000 billion in
GDPe, then how much would G have to
↑ to reach a YF of $2000 billion?
•
•
•
•
•
$2000B
$1000B
$500B
$200B
$100B
If $500 B in spending gives rise to
$1000 B in GDP, the multiplier is 2;
therefore, $500B increase in G would
increase GDP by another $1000 to
reach YF of $2000.
The value of the spending multiplier
decreases when?
A.
B.
C.
D.
Tax rates are decreased
Exports decrease
Imports decrease
Government
expenditures decrease
E. The MPS increases
If the amount of saving as a fraction of a change in Y
increases, less is spent; therefore, the multiplier is lessened.
Which of the following best explains why
equilibrium income will rise by more than
$100 in response to a $100 increase in G?
A.
B.
C.
D.
E.
Incomes will ↑ → ↓ taxes
Incomes will ↑ → ↑C
↑AE → PL
↑AE → ↑MS → ↓ I
↑budget deficit → ↓AE
In a closed economy with no taxes in which
the APC is 0.75, which of the following is
true?
A.
B.
C.
D.
E.
If income is $100, then saving is $75
If income is $100, then C is $50
If income is $200, then saving is $50
If income is 200, then C is $75
If income is $500, then S is $100
If income is $200, then consumption is $150 and saving is $50.
APC (Yd) = C = .75(200) = 150. S = Yd – C = $200 – 150 = 50.
Suppose that disposable income is $1000,
consumption is $700, and the MPC is 0.6.
If disposable income increases by $100,
consumption and saving will equal which of
the following?
Consumption
A.
B.
C.
D.
E.
420
600
660
660
760
Saving
280
400
320
440
340
S = $1000 - $700 = $300
ΔC = MPC (YD) = $60
ΔS = 100 – 60 = $40
Therefore, C changes from
$700 to $760 and saving
changes
from $300 to $340.
If the MPC increases, the equilibrium levels
of income and consumption will change in
which of the following ways?
An increase in the amount of consumption that results from a
change in Yd results in a greater impact on income and
consumption through the multiplier.
Level of Income
Level of Consumption
A.
B.
C.
D.
E.
No change
No change
Increase
Increase
Decrease
No change
increase
No change
Increase
Decrease
If private investment of 100 is added to the
economy, the equilibrium level of income
and consumption will change in which of
the following ways?
Level of Income
A.
B.
C.
D.
E.
increase
increase
increase
No change
No change
Level of Consumption
decrease
increase
no change
increase
no change
A small change in
spending will result
in additional increases
in Yd and C through
the multiplier.
If at full employment, government wants to
increase its spending by $100 billion
without inflation in the short run, it must do
which of the following?
A.
B.
C.
D.
E.
↑ Taxes by greater than $100 B
↑ Taxes by $100B
↑ Taxes by less than $100 B
↓ Taxes by $100 B
↓ Taxes by less than $100 B
A change in G has a greater effect on GDP than an equal change in
taxes; therefore, taxes must be increased by greater than the amount
of increase in G to offset the effect of G on the economy.
If AE ↑
from 200 to 300 solely due
to a change in G and results in a
change in GDPe of 1000 to 1500,
which of the following is true?
A.
B.
C.
D.
E.
G is 300 and the multiplier is 5
G is 100 and the multiplier is 5
G is 100 and C increases by 500
G and GDP increase by 500 each
C and GDP increase by 500 each
If a ΔAE of 100 results in a Δ in GDP of $500, the multiplier is 5.
Suppose that disposable income is $1000,
consumption is $700, and the MPC is 0.6.
If disposable income increases by $100,
consumption and saving will equal which of
the following?
A.
B.
C.
D.
E.
G is 300 and the multiplier is 5
G is 100 and the multiplier is 5
G is 100 and C increases by 500
G and GDP increase by 500 each
C and GDP increase by 500 each
omit
Suppose that disposable income is $1000,
consumption is $700, and the MPC is 0.6.
If disposable income increases by $100,
consumption and saving will equal which of
the following?
A.
B.
C.
D.
E.
G is 300 and the multiplier is 5
G is 100 and the multiplier is 5
G is 100 and C increases by 500
G and GDP increase by 500 each
C and GDP increase by 500 each
omit
Current equilibrium output is equal to
$2,500,000, potential output is equal to
$2,600,000 and the MPC is equal to 0.75.
Under these conditions a Keynesian
economist is most likely to recommend?
A.
B.
C.
D.
E.
Decrease taxes by $25,000
Decrease taxes by $100,000
Increase gov. expenditures by $25,000
Increase gov expenditures by $33,333
Increase gov expenditures by $100,000
The GDP gap = 2,600,000 – 2,500,000 = 100,000. The multiplier = 1/1-MPC = 4.
ΔGDP = M x Δ AE = 100,000= 4 x ?. Therefore, Δ AE = 25,000.
According to Keynesian theory, the most
important determinant of saving and
consumption is the:
A.
B.
C.
D.
E.
Interest rate
Price level
Level of income
Level of employment
Flexibility of wages and prices
An increase in the money supply will have
the greatest effect on real GDP if:
A. The MPC is low
B. Unemployment is very low
C. Investment spending is not sensitive to interest
rates
D. The quantity of money demanded is not very
sensitive to interest rates
E. The required reserve ratio is low.
Inflationary and Recessionary Gaps
Recessionary Gap:
Gap The amount by which aggregate
expenditures fall short of the amount of spending
needed to purchase the full employment level of
output (potential output).
Inflationary Gap:
Gap The amount by which aggregate
expenditures exceed the amount of spending
needed to purchase the full employment level of
output (potential output).
Inflationary and Recessionary Gaps
PL
LRAS
SRAS
PL
LRAS
AD
AD
YF
SRAS
GDPR
Indicates a recessionary gap exists. Not
enough spending to purchase the YF
output.
YF
GDPR
Indicates an inflationary gap exists.
Spending exceeds the amount needed to
purchase the YF output.