© 2013 Pearson
Aggregate Expenditure
Multiplier
30
CHECKPOINTS
© 2013 Pearson
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Checkpoint 30.1 Checkpoint 30.2
Problem 1
Problem 2
Problem 1
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Problem 2
Checkpoint 30.3
Problem 1
Problem 2
Problem 3
Problem 3
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Problem 3
In the news
Problem 4
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In the news
In the news
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Checkpoint 30.4
Problem 1
Problem 2
In the news
© 2013 Pearson
CHECKPOINT 30.1
Practice Problem 1
The marginal propensity to consume is 0.8.
If disposable income increases by $0.5 trillion, by how
much will consumption expenditure change?
© 2013 Pearson
CHECKPOINT 30.1
Solution
The marginal propensity to consume is the fraction of a
change in disposable income that is spent on
consumption.
Consumption expenditure will increase by 0.8 multiplied by
the change in disposable income of $0.5 trillion.
Consumption expenditure will increase $0.4 trillion.
© 2013 Pearson
CHECKPOINT 30.1
Practice Problem 2
Explain how each of the following events influences the
U.S. consumption function:
• The marginal propensity to consume decreases.
• U.S. autonomous consumption decreases.
• Americans expect an increase in future income.
© 2013 Pearson
CHECKPOINT 30.1
Solution
The marginal propensity to consume equals the slope of
the consumption function.
So when the marginal propensity to consume decreases,
the consumption function becomes flatter.
Autonomous consumption is the y-axis intercept of the
consumption function.
So when autonomous expenditure decreases, the
consumption function shifts downward.
© 2013 Pearson
CHECKPOINT 30.1
When expected future income increases, current
consumption expenditure increases.
The consumption function shifts upward.
© 2013 Pearson
CHECKPOINT 30.1
Study Plan Problem
When the marginal propensity to consume
decreases, the U.S. consumption function
___________.
A.
B.
C.
D.
becomes flatter
becomes steeper
shifts upward
shifts downward
© 2013 Pearson
CHECKPOINT 30.1
When when autonomous expenditure decreases, the
U.S. consumption function ___________.
A.
B.
C.
D.
becomes flatter
becomes steeper
shifts upward
shifts downward
© 2013 Pearson
CHECKPOINT 30.1
When expected future income increases, the U.S.
consumption function ___________.
A.
B.
C.
D.
becomes flatter
becomes steeper
shifts upward
shifts downward
© 2013 Pearson
CHECKPOINT 30.1
Practice Problem 3
The figure shows the
consumption function.
What is the marginal propensity
to consume, and what is
autonomous consumption?
© 2013 Pearson
CHECKPOINT 30.1
Solution
When disposable income
increases by $100 billion,
consumption expenditure
increases by $80 billion.
MPC is $80 billion ÷ $100 billion.
= 0.8.
Autonomous consumption
(consumption expenditure that is
independent of disposable
income) equals the y-axis intercept
and is $80 billion.
© 2013 Pearson
CHECKPOINT 30.1
In the news
Personal income falls as spending rises
Personal income fell 0.1% in August, after increasing 0.1%
in July, while personal spending rose just 0.2% in August,
after rising 0.8% in July.
Source: CNN Money, September 30, 2011
How can consumers increase spending when personal
income falls?
Does the rise in consumer spending arise from a
movement along the consumption function or a shift of the
consumption function? Explain your answer.
© 2013 Pearson
CHECKPOINT 30.1
Solution
Other things remaining the same, a fall in personal income
brings a fall in consumption expenditure in a movement
along the consumption function.
When an incraese in consumption expenditure occurs at
the same time that personal income decreases, the
consumption function has shifted upward.
Autonomous consumption expenditure has increased as
households spent part of their past savings.
© 2013 Pearson
CHECKPOINT 30.2
Practice Problem 1
The table gives real GDP (Y)
and its components in billions
of dollars.
Calculate aggregate planned
expenditure when real GDP is
$200 billion and when real
GDP is $600 billion.
© 2013 Pearson
CHECKPOINT 30.2
Solution
Aggregate planned expenditure
equals
C + I + G + X – M.
When real GDP is $200 billion,
aggregate planned expenditure
equals
($170 + $50 + $60 + $60  $30) billion
= $310 billion.
© 2013 Pearson
CHECKPOINT 30.2
Aggregate planned expenditure
equals
C + I + G + X – M.
When real GDP is $600 billion,
aggregate planned expenditure
equals
($410 + $50 + $60 + $60  $90) billion
= $490 billion.
© 2013 Pearson
CHECKPOINT 30.2
Study Plan Problem
The table gives real GDP (Y)
and its components in billions of
dollars.
If real GDP is $200 billion, then
aggregate planned expenditure
is _____.
A.
B.
C.
D.
$340 billion
$370 billion
$310 billion
$280 billion
© 2013 Pearson
CHECKPOINT 30.2
The table gives real GDP (Y)
and its components in billions
of dollars.
If real GDP is $600 billion,
then aggregate planned
expenditure is _____.
A.
B.
C.
D.
$670 billion
$490 billion
$580 billion
$550 billion
© 2013 Pearson
CHECKPOINT 30.2
Practice Problem 2
The table gives real GDP (Y)
and its components in billions
of dollars.
Calculate equilibrium
expenditure.
© 2013 Pearson
CHECKPOINT 30.2
Solution
Equilibrium expenditure occurs
when aggregate planned
expenditure equals real GDP.
When real GDP is $400 billion,
aggregate planned expenditure
equals
($290 + $50 + $60 + $60 – $60) billion
= $400 billion.
Equilibrium expenditure is $400 billion.
© 2013 Pearson
CHECKPOINT 30.2
Practice Problem 3
The table gives real GDP (Y)
and its components in billions
of dollars.
If real GDP is $200 billion,
explain the process that moves
the economy toward
equilibrium expenditure.
© 2013 Pearson
CHECKPOINT 30.2
Solution
If real GDP is $200 billion,
aggregate planned expenditure is
$310 billion.
Aggregate planned expenditure
exceeds real GDP, so firms’
inventories decrease.
Expenditure plans are not fulfilled.
© 2013 Pearson
CHECKPOINT 30.2
Firms increase production to
restore their inventories
Real GDP increases.
As long as aggregate planned
expenditure exceeds real GDP,
firms will increase production to
restore their inventories to their
target level.
Real GDP will increase until real
GDP is $400 billion—equilibrium
expenditure.
© 2013 Pearson
CHECKPOINT 30.2
Study Plan Problem
If real GDP (Y) is $200 billion,
an unplanned ______ in
inventories leads firms to
_____ production, which _____
real GDP toward equilibrium.
A.
B.
C.
D.
E.
increase; decrease; decreases
decrease; decrease; decreases
increase; decrease; increases
decrease; increase; increases
decrease; increase; decreases
© 2013 Pearson
CHECKPOINT 30.2
Practice Problem 4
The table gives real GDP (Y)
and its components in billions
of dollars.
If real GDP is $600 billion,
explain the process that moves
the economy toward
equilibrium expenditure.
© 2013 Pearson
CHECKPOINT 30.2
Solution
If real GDP is $600 billion,
aggregate planned expenditure is
$490 billion.
Aggregate planned expenditure is
less than real GDP, so firms’
inventories increase.
Firms cut production and try to
reduce their inventories.
Real GDP decreases.
© 2013 Pearson
CHECKPOINT 30.2
As long as aggregate planned
expenditure is less than real GDP,
firms’ inventories will increase.
Firms will cut production and try to
reduce their inventories to their
target level.
Real GDP decreases.
© 2013 Pearson
CHECKPOINT 30.2
Study Plan Problem
If real GDP is $600 billion, an
unplanned _______ in inventories
leads firms to _______
production, which ______ real
GDP toward equilibrium.
A.
B.
C.
D.
E.
increase; decrease; decreases
decrease; decrease; decreases
increase; decrease; increases
decrease; increase; increases
decrease; increase; decreases
© 2013 Pearson
CHECKPOINT 30.2
In the news
Wholesale inventories decline, sales rise
Wholesale inventories fell 1.3 percent in August, which
helped depress economic output during the recession.
Rising sales might encourage businesses to begin
restocking their inventories, which would help boost
economic growth.
Source: The New York Times, October 8, 2009
Explain why a fall in inventories is associated with
recession and a restocking of inventories might bolster
economic growth.
© 2013 Pearson
CHECKPOINT 30.2
Solution
When firms reduce their target level of inventories,
planned investment falls and equilibrium expenditure
and real GDP decrease—as occurred during the year to
August 2009.
When firms plan to restock their inventories, the reverse
occurs. Equilibrium expenditure and real GDP increase.
© 2013 Pearson
CHECKPOINT 30.3
Practice Problem 1
An economy has no imports and no income taxes, MPC is
0.80, and real GDP is $150 billion.
Businesses increase investment by $5 billion.
Calculate the multiplier and the change in real GDP.
© 2013 Pearson
CHECKPOINT 30.3
Solution
The multiplier equals 1/(1 – MPC).
MPC is 0.8, so the multiplier is 5.
The multiplier = Change in real GDP ÷ Investment
Change in real GDP = Investment × Multiplier
= $5 billion × 5.
Real GDP increases by $25 billion.
The increase in investment increases real GDP by the
multiplier (5) times the change in investment ($5 billion).
© 2013 Pearson
CHECKPOINT 30.3
Practice Problem 2
An economy has no imports and no income taxes, MPC is
0.80, and real GDP is $150 billion.
Businesses increase investment by $5 billion.
Calculate the new level of real GDP and explain why real
GDP increases by more than $5 billion.
© 2013 Pearson
CHECKPOINT 30.3
Solution
The multiplier equals 1/(1 – MPC).
MPC is 0.8, so the multiplier is 5.
The increase in investment increases real GDP by the
multiplier (5) times the change in investment ($5 billion).
Real GDP increases by $25 billion to $175 billion.
Real GDP increases by more than $5 billion because the
increase in investment induces an increase in
consumption expenditure.
© 2013 Pearson
CHECKPOINT 30.3
Practice Problem 3
An economy has no imports and no income taxes.
An increase in autonomous expenditure of $2 trillion
increases equilibrium expenditure by $8 trillion.
Calculate the multiplier and the marginal propensity to
consume.
© 2013 Pearson
CHECKPOINT 30.3
Solution
The multiplier equals the increase in equilibrium
expenditure ($8 trillion) divided by the increase in
autonomous expenditure ($2 trillion).
The multiplier is 4.
The multiplier is 1/(1 – MPC).
So 4 = 1/(1 – MPC), and MPC is 0.75.
The marginal propensity to consume is 0.75.
© 2013 Pearson
CHECKPOINT 30.3
Study Plan Problem
In an economy has no imports and no income taxes,
an increase in autonomous expenditure of $2 trillion
increases equilibrium expenditure by $8 trillion.
Calculate the multiplier and the marginal propensity
to consume.
A. 4; 0.25
B. 0.25; –3.0
C. 4; 0.75
D. 0.75; 4
© 2013 Pearson
CHECKPOINT 30.3
In the news
Keystone XL pipeline—Alberta to the Gulf of Mexico
TransCanada says building the $7 billion pipeline would put
20,000 Americans directly to work during the construction
phase and add an expected 118,000 spin-off jobs. The
project would also pump $20 billion into the U.S. economy.
Source: CNN Money, September 30, 2011
Explain how TransCanada’s investment of $7 billion could
create spin-off jobs and pump $20 billion into the U.S.
economy.
© 2013 Pearson
CHECKPOINT 30.3
Solution
The investment of $7 billion will increase real GDP by
more than $7 billion because the investment multiplier
exceeds 1.
When construction begins, new jobs are created and
these workers will receive an income.
They will spend part of it on consumption goods and
services, which in turn will create jobs in other
industries—spin-off jobs.
© 2013 Pearson
CHECKPOINT 30.3
These workers will earn an income.
They will spend part of the income on consumption
goods and services.
TransCanada says that the multiplier is
$20 billion ÷ $7 billion, which is almost 3, an optimistic
estimate.
© 2013 Pearson
CHECKPOINT 30.4
Practice Problem 1
The table sets out the aggregate expenditure schedules.
Make a graph of the AE curves at each price level.
On the graph, mark the equilibrium expenditure at each
price level.
© 2013 Pearson
CHECKPOINT 30.4
Solution
© 2013 Pearson
CHECKPOINT 30.4
When the price level is 90,
equilibrium expenditure is
$4 trillion.
When the price level is 100,
equilibrium expenditure is
$3 trillion.
When the price level is 110,
equilibrium expenditure is
$2 trillion.
© 2013 Pearson
CHECKPOINT 30.4
Practice Problem 2
The table sets out the aggregate expenditure schedules.
Construct the aggregate demand schedule and plot the
AD curve.
© 2013 Pearson
CHECKPOINT 30.4
Solution
The quantity of real GDP
demanded at each price
level equals the equilibrium
expenditure.
For example, at a price level
of 90, the quantity of real
GDP demanded is $4 trillion.
© 2013 Pearson
CHECKPOINT 30.4
The table sets out the
aggregate demand schedule
and the figure plots the data.
© 2013 Pearson
CHECKPOINT 30.4
In the news
Price jump worst in 3 years
An increase in the price of essentials such as oil, food and
cotton left U.S. consumers struggling with the highest
inflation rate in three years.
Source: CNN Money, September 26, 2011
Explain the effect of a rise in the price level on equilibrium
expenditure.
© 2013 Pearson
CHECKPOINT 30.4
Solution
A rise in the price level decreases consumption
expenditure, which decreases aggregate planned
expenditure and shifts the AE curve downward.
Equilibrium expenditure decreases.
© 2013 Pearson