Aggregate Expenditure:
The Multiplier, Government Sector,
& the Open Economy
True or False:
1) The equilibrium level of GDP will change in response to changes in the investment
schedule.
2) An increase in the real rate of interest will, other things equal, result in an increase in the
equilibrium real GDP.
3) The multiplier is equal to the change in real GDP divided by the initial change in
spending.
4) The multiplier is the reciprocal of the marginal propensity to consume.
5) The multiplier will be larger the steeper the slope of the saving schedule.
6) The lower the marginal propensity to consume, the larger is the multiplier.
7) Exports are a leakage from the circular flow of an economy.
8) Both an increase in net exports and investments would tend to raise the equilibrium level
of GDP.
9) The balanced-budget multiplier indicates that equal increases in government spending and
taxation will increase the equilibrium GDP.
10) A decrease in taxes will have a greater effect on equilibrium GDP the smaller the
marginal propensity to consume.
11) A recessionary gap is the amount by which aggregate expenditures exceed those
occurring at the full-employment level of GDP.
12) The aggregate expenditures model does not indicate how much the price level will rise
when aggregate expenditures are excessive relative to the economy's capacity.
2
Multiple Choice :
(1) The magnification of small changes in spending into larger changes in output and income
is produced by :
A)
B)
C)
D)
the average propensity to consume .
the paradox of thrift .
the multiplier effect .
saving.
(2) The multiplier can be calculated by dividing :
A)
B)
C)
D)
the initial change in spending by the change in real GDP .
the change in real GDP by the initial change in spending .
one by one minus the marginal propensity to save .
one by one minus the marginal propensity to invest.
(3) Generally speaking, the greater the MPS, the :
A)
B)
C)
D)
smaller would be the increase in domestic output which results from an
increase in investment spending .
larger would be the increase in domestic output which results from an increase
in investment spending .
larger would be the increase in domestic output which results from a decrease
in investment spending .
smaller would be the increase in domestic output which results from a
decrease in investment spending.
(4) If the MPC is .75, the multiplier will be :
A)
C)
2
3.5
B)
D)
3
4
(5) The value of the marginal propensity to consume is 0.8. If real GDP increases by kd 30
million, this situation was the result of an increase in the aggregate expenditures
schedule of:
A)
C)
kd 5 million.
kd 8 million.
B)
D)
kd 6 million.
kd 42 million.
(6) Assume the MPC is 0.6. If investment spending increases by kd 8 million, the level of
GDP will increase by :
A)
C)
kd 8 million
kd 35 million
B)
D)
kd 33.3 million .
kd 42 million.
(7) An initial increase in investment spending will generate :
A)
B)
C)
D)
less of an increase in real GDP than the initial increase because of the
multiplier effect .
more of an increase in real GDP than the initial increase because of the
multiplier effect .
more of an increase in real GDP than the initial increase because of the net
export effect .
less of an increase in real GDP than the initial increase because of the
net export effect.
3
(8) In a closed economy with no government, an increase in autonomous investment of kd 25
million increases domestic output from kd 600 million to kd 700 million. The
marginal propensity to consume is :
A)
B)
C)
D)
2.45 and the multiplier is 4 .
2.52 and the multiplier is 2 .
2..5 and the multiplier is 4 .
2.82 and the multiplier is 5.
(9) When net exports are negative :
A)
B)
C)
D)
net exports exceed imports .
depreciation exceeds exports .
exports exceed imports .
imports exceed exports.
(10) A decrease in taxes will have a greater effect on equilibrium GDP the :
A)
B)
C)
D)
smaller the marginal propensity to consume .
larger the marginal propensity to save .
larger the marginal propensity to consume .
larger the average propensity to save.
(11) Leakages from the income-expenditure stream are :
A)
B)
C)
D)
consumption, saving, and transfers .
saving, taxes, and transfers .
saving, taxes, and imports .
imports, taxes, and transfers.
C,Ig
C+Ig
C
054
054
054
54
252
4
50
150
350
450
GDP
550
(12) The multiplier for the above economy is :
A)
2
B)
C)
4
D)
3
5
4
(13) Other things being equal, the effect of a downward shift of the economy's net export
schedule on equilibrium GDP will be similar to a(n) :
A)
B)
C)
D)
rightward shift in the investment-demand schedule .
downward shift in the consumption schedule .
upward shift in the consumption schedule .
upward shift in the investment schedule.
(14) Other things being equal, a decrease in an economy's exports will :
A)
B)
C)
D)
increase domestic aggregate expenditures and the equilibrium level of GDP .
decrease domestic aggregate expenditures and the equilibrium level of GDP .
have no effect on domestic GDP because imports will offset change in exports .
decrease the marginal propensity to import.
(15) Within the aggregate expenditure-domestic output framework, a downward shift in
aggregate expenditures can be caused by a(n(:
A)
B)
C)
D)
increase in taxes or a decrease in government spending .
decrease in taxes or an increase in government spending .
increase in consumption or an increase in government spending .
increase in consumption or a decrease in taxes.
The table shows a private, open economy. All figures are in millions of dinars.
Real GDP C + I g
kd 400
450
500
550
600
650
700
kd 420
460
500
540
580
620
660
Net Exports
kd 20
20
20
20
20
20
20
(16) Refer to the above table. The equilibrium real GDP is:
A)
C)
kd 550
kd 650
B)
D)
kd 600
kd 700
(17) Refer to the above table. If net exports increased by kd10 million at each level of GDP,
the equilibrium real GDP would be:
A)
C)
kd 550
kd 650
B)
D)
kd 600
kd 700
(18) Refer to the above table. If the marginal propensity to consume in this economy is 0.8,
a kd 10 increase in its net exports would increase its equilibrium real GDP by:
A)
C)
kd 25
kd 100
B)
D)
kd 50
kd 200
(19) Injections into the income-expenditure stream include :
A)
C)
investment and imports
transfers and imports
B)
D)
investment and exports
transfers and exports.
5
The data are for a no-government economy. All figures are in millions of dinars.
GDP
kd 440
490
540
590
640
C
kd 450
490
530
570
610
(20) Refer to the above data. If gross investment is kd 20 million at all levels of GDP and
net exports are zero, the equilibrium GDP will be :
A)
C)
292 million.
592 million.
B)
D)
522 million .
022 million.
(21) Refer to the above data. If a lump-sum tax of kd 30 million is imposed at all levels of
GDP and net exports are zero, the consumption schedule becomes :
A)
C)
420, 460, 500, 540, 580
430, 470, 510, 550, 590
B)
D)
426, 466, 506, 546, 586.
432, 472, 512, 552, 592.
(22) Refer to the above data. If gross investment is kd 34 million, net exports are zero, and
there is a lump-sum tax of kd 30 million at all levels of GDP, then the after-tax
equilibrium level of GDP will be :
A)
C)
kd 292 million
kd 592 million
B)
D)
kd 522 million .
kd 022 million.
(23) Refer to the above data. Given the levels of investment at kd 34 million, zero net exports,
and a lump-sum tax of kd 30 million, the addition of government expenditures of kd 20
million at each level of GDP will result in an equilibrium GDP of :
A)
C)
kd 292 million
kd 592 million
B)
D)
kd 522 million .
kd 022 million.
All figures are in millions of dinars.
GDP
kd 240
250
260
270
280
290
300
310
320
C
kd 244
250
256
262
268
274
280
286
292
(24) Refer to the above data. If gross investment is kd 8 million, net exports are zero, and
there is no government, the equilibrium level of GDP will be :
A)
C)
kd 402 million
kd 482 million
B)
D)
kd 4.2 million .
kd 492 million.
6
(25) Refer to the above data. If gross investment is kd 10 million, net exports are kd 6
million, and there is no government, the equilibrium level of GDP will be :
A)
C)
kd 402 million
kd 482 million
B)
D)
kd 4.0 million .
kd 492 million.
(26) Refer to the above data. Gross investment is kd 8 million, net exports are kd 4 million,
and government collects a lump-sum tax of kd 30 million and spends kd 30 million.
Assume all taxes are personal taxes and that government spending does not entail
shifts in the consumption and investment schedules. The equilibrium GDP will be :
A)
C)
482 million
322 million
B)
D)
492 million .
332 million.
(27) The balanced-budget multiplier suggests that when taxes and government spending
are increased by the same amount, there will be :
A)
B)
C)
D)
no change in the equilibrium level of aggregate expenditures .
a decrease in the equilibrium level of aggregate expenditures .
an increase in the equilibrium level of aggregate expenditures .
first an increase and then a decrease in the equilibrium level of aggregate
expenditures.
(28) If the marginal propensity to consume is 0.80 and both taxes and government
purchases increase by kd 50 million, GDP will :
A)
C)
increase by kd 50 million
increase by kd 10 million
B)
D)
decrease by kd 50 million .
decrease by kd 10 million.
(29) The effect of a decline in taxes on the level of income will differ somewhat from an
increase in government expenditures of the same amount because :
A)
B)
C)
D)
tax declines tend to be more expansionary .
households may not spend all of an increase in disposable income .
the MPC which applies to the incomes of households always exceeds the
MPC which applies to business incomes .
the multiplier is high when the MPS is low.
AE
C+Ig+Xn
C+Ig
322
C
342
322
82
252
2
322
422
322
222
GDP
7
(30) In the above graph it is assumed that investment, net exports, and government
expenditures :
A)
C)
are all negative
vary inversely with GDP
B)
D)
vary directly with GDP .
are independent of GDP.
(31) Refer to the above graph. The size of the multiplier associated with changes in
government spending in this economy is :
A)
C)
4.22
5.22
B)
D)
3.52
0.0.
(32) In a recessionary gap, the equilibrium level of real GDP is :
A)
B)
C)
D)
less than planned investment .
equal to full-employment GDP .
greater than full-employment GDP .
less than full-employment GDP .
(33) The amount by which an aggregate expenditures schedule must shift downward to
eliminate demand-pull inflation and still achieve the full-employment GDP is a(n) :
A)
C)
inflationary gap.
depreciation rate.
B)
D)
recessionary gap.
price level change.
(34) In an inflationary gap, the equilibrium level of real GDP would be :
A)
B)
C)
D)
greater than planned investment .
equal to full-employment GDP .
greater than full-employment GDP .
less than full-employment GDP.
(35) If the MPC in an economy is 0.8, government could eliminate a recessionary gap of kd
100 million by cutting taxes by:
A)
C)
82 million.
345 million.
B)
D)
322 million.
422 million.
(36) Assume that the marginal propensity to consume in an economy is 0.75. If the
economy's full-employment real GDP is kd 900 million and its equilibrium real
GDP is kd 800 million, there is a recessionary gap of:
A)
C)
45 million.
333 million.
B)
D)
322 million.
222 million.
(37) To eliminate an inflationary gap of kd 20 million in an economy with a marginal
propensity to consume of 0.8, it would be necessary to:
A)
B)
C)
D)
decrease the aggregate expenditures schedule by kd 20 million.
decrease the aggregate expenditures schedule by kd 4 million.
increase the aggregate expenditures schedule by kd 20 million.
increase the aggregate expenditures schedule by kd 4 million.
8
(38) The amount by which aggregate expenditures exceed those associated with the fullemployment level of domestic output can best be described as :
A)
C)
a recessionary gap
the multiplier
B)
D)
an inflationary gap .
the average propensity to save.
(39) If the MPC is 0.80, all taxes are lump-sum taxes, and the equilibrium GDP is kd 25
million below the full-employment GDP, then the size of the recessionary gap is :
A)
C)
4 million
5 million
B)
D)
2 million .
0 million.
(40) In an open mixed economy, the inflationary gap may be described as the :
A)
B)
C)
D)
excess of GDP over Ca + Ig + Xn + G at the full-employment output .
excess of Sa + M + T over Ig + X + G at the full-employment GDP .
extra consumption that occurs when investment increases in a
full-employment economy .
excess of Ca + Ig + Xn + G at the full-employment GDP.
(41) The amount by which the full-employment level of domestic output exceeds the level of
aggregate expenditure can best be described as :
A)
C)
a recessionary gap
the multiplier
B)
D)
an inflationary gap .
the marginal propensity to save.
Essay Questions:

What is the relationship between the multiplier and the marginal
propensities?

What is the effect of net exports, either positive or negative, on equilibrium
GDP?

Describe the probable impact of an increase in government spending
assuming no change in taxes or private spending and less than fullemployment output.

Identify the relationship between GDP, taxes, and disposable income.

“If taxes and government spending are increased by the same amount, there
will still be a positive effect on equilibrium GDP.” Explain.

Compare and contrast the recessionary gap and the inflationary gap.
9
Problems:
1) The data in the first two columns below are for a closed economy. Use this table
to answer the following questions.
Real GDP Aggregate
Net
Aggregate
= DI
expenditures Exports Imports exports expenditures
(millions) (millions) (millions) (millions) (millions) (millions)
kd100
kd120
kd10
kd15
kd___
kd___
125
140
10
15
___
___
150
160
10
15
___
___
175
180
10
15
___
___
200
200
10
15
___
___
225
220
10
15
___
___
250
240
10
15
___
___
275
260
10
15
___
___
(a) What is the equilibrium GDP for the closed economy?
(b) Including the international trade figures for exports and imports, calculate net exports
and determine the equilibrium GDP for an open economy.
(c) What happens to equilibrium GDP if exports were kd 5 billion larger at each level of GDP?
(d) What will happen to equilibrium GDP if exports remained at kd 10 billion, but imports
dropped to kd 5 billion?
(e) What is the size of the multiplier in this economy?
------------------------------------------------------------------
2) Refer to the following table to answer the questions.
(1) Possible levels (2) Real domestic
(3) AE
of employment,
output,
(Ca + Ig + Xn +G)
millions
billions
billions
45
50
55
60
65
kd250
275
300
325
350
kd260
280
300
320
340
(a) If full employment in this economy is 65 million, will there be an inflationary or
recessionary gap? What will be the consequence of this gap? By how much would
aggregate expenditures in column 3 have to change at each level of GDP to eliminate
the inflationary or recessionary gap? Explain.
(b) Will there be an inflationary or recessionary gap if the full-employment level of output is
kd 250 billion? Explain the consequences. By how much would aggregate
expenditures in column 3 have to change at each level of GDP to eliminate the
inflationary or recessionary gap? Explain.
(c) Assuming that investment, net exports, and government expenditures do not change with
changes in real GDP, what are the sizes of the MPC, the MPS, and the multiplier?
----------------------------------------------
10
3) Use the table below to answer the following questions:
Real GDP
kd500
510
520
530
540
550
560
C
kd495
504
513
522
531
540
549
(a) What is the size of the multiplier in this economy?
(b) If taxes were zero, government purchases were kd 5, investment is kd 3, and net exports
are zero, what is the equilibrium GDP?
(c) If taxes are kd 10, government purchases are kd 10, investment is kd 6, and net exports
are zero, what is the equilibrium GDP?
(d) Assume investment is kd 50, taxes are kd 50, and net exports and government purchases
are each zero. The full-employment level of GDP is kd 545. How much of a
reduction in taxes is needed to eliminate the recessionary gap?
---------------------------------------------4) If there is a recessionary gap of kd 100 billion and the MPC is 0.80, by how much
must taxes be reduced to eliminate the recessionary gap?