Economics (McConnell), AP Edition, 20th Edition Chapter (20).docx

Chapter 29: The Aggregate Expenditures Model Multiple-Choice Questions 1. Classical theorists believed that if total spending in the economy fell below full-employment output, (A) the economy would self-correct through lower wages and prices (B) government should intervene by raising spending (C) government should correct the problem by raising taxes (D) the economy would tend to remain below full-employment output for months (E) lower imports and increased exports would correct the imbalance (A) Classical economists believed the economy would correct itself, because lower demand would lead to lower prices and wages, which would lead to higher spending again, correcting to full-employment output automatically. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Stabilization Policies Book Section: Say’s Law, the Great Depression, and Keynes 2. An unexpected increase in inventories would signal firms to (A) hire more workers (B) raise wages (C) decrease output (D) raise product prices (E) increase the cost of production (C) An unexpected increase in inventories indicates that consumer demand for products has decreased and firms should reduce production. Difficulty: Easy Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Aggregate Demand Book Section: Assumptions and Simplifications 3. Which of the following is a leakage from the circular market flow? (A) Investment (B) Exports (C) Government spending (D) Consumer spending (E) Saving (E) Saving represents income not spent in the circular flow and a leakage from the amount of spending in the economy. Difficulty: Easy Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Circular Flow Book Section: Saving Equals Planned Investment 4. According to Keynesian theory, an increase in investment spending causes (A) a decrease in the national debt (B) a decrease in the price level (C) an increase in tax revenues (D) an increase in output (E) a decrease in imports (D) Increased investment spending increases aggregate demand, which increases nominal GDP. An increase in nominal GDP will increase the real GDP, the price level, or both. If real GDP increases, then output and employment will also increase. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Real Output and Price Level Book Section: Saving Equals Planned Investment 5. At equilibrium GDP, (A) unplanned inventories are greater than planned inventories (B) there are no unplanned inventories (C) planned inventories are greater than saving (D) unplanned inventories are increasing (E) planned inventories are zero (B) At equilibrium GDP, there are no unplanned inventories; firms sell what they produce, though some planned inventories may exist. If firms find that their inventories are building unexpectedly, then that addition to planned inventories is termed an unplanned business investment. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Macroeconomic Equilibrium Book Section: No Unplanned Changes in Inventories 6. All of the following factors would increase equilibrium GDP EXCEPT (A) incomes abroad increasing (B) the international value of the dollar depreciating (C) foreign countries increasing trade barriers on U.S. products (D) tax rates decreasing (E) government spending increasing (C) Trade barriers result in less foreign spending for U.S. products, reducing exports and net trade. If net exports decrease, then aggregate demand and equilibrium GDP will also decrease. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Macroeconomic Equilibrium Book Section: International Economic Linkages 7. If government wants to change both spending and taxes without affecting real GDP, it must (A) increase spending by more than it increases taxes (B) decrease spending by more than it decreases taxes (C) increase spending by more than it decreases taxes (D) increase spending by less than it increases taxes (E) decrease spending by more than it increases taxes (D) A change in government spending has a direct effect on the economy; an increase in government spending of $10 billion will increase aggregate demand by $10 billion. But a change in tax will affect both saving and consumption. A tax increase of $10 billion will change consumption by MPC x $10 billion. If the marginal propensity to consume were 0.8, the change in consumption and aggregate demand would be $8 billion. Difficulty: Hard Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Demand-Side Effects Book Section: Taxation and Equilibrium GDP 8. If the economy experiences a recession with a current spending gap $1,000 below full-employment output, and the marginal propensity to consume is 0.8, how much must government increase spending to restore the economy to full-employment GDP? (A) $ 500 (B) $ 200 (C) $ 800 (D) $ 5 (E) $ 20 (B) If MPC = 0.8, the spending multiplier is 5 (1 / MPS = 1 / 0.2 = 5). To increase GDP by a $1,000 recessionary gap, the government must increase spending by $200, which is subject to the multiplier ($200 x 5), to create the $1,000. Difficulty: Hard Style: Application AP Economics Curricular Requirement Macroeconomics: Demand-Side Effects Book Section: Recessionary Expenditure Gap 9. When saving equals planned investment I. the economy is in equilibrium and at full-employment GDP II. the economy is neither in equilibrium nor at full-employment GDP III. the economy is in equilibrium, but not necessarily at full-employment GDP IV. there are no unplanned changes to inventories (A) I only (B) III only (C) I and IV only (D) II and IV only (E) III and IV only (E) If saving equals planned investment, the economy is in equilibrium, but not necessarily at full-employment GDP. As the economy is in equilibrium, the level of saving must equal the level of planned investment and there are no unplanned changes to inventories. While economy may be in equilibrium in the short run, it does not necessarily mean that the economy is at a level of full-employment GDP (potential output). Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Macroeconomic Equilibrium Book Section: Saving Equals Planned Investment 10. If unplanned business inventories increase (A) production will decrease, but real GDP will remain constant (B) production will remain constant, but real GDP will fall (C) production and real GDP will fall (D) investment and real GDP will rise (E) investment will rise and real GDP will fall (C) If there are unplanned increases in inventories, firms will reduce production. As production decreases, real GDP will decrease, as well. Difficulty: Easy Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Macroeconomic Equilibrium Book Section: Saving Equals Planned Investment 11. If the expected real rate of return on investment were to increase (A) investment would increase, but real GDP would decrease (B) investment would increase and real GDP would increase (C) investment would remain constant, but real GDP would increase (D) investment would remain constant, but real GDP would decrease (E) investment would increase, but real GDP would remain constant (B) An increase in the expected real rate of return of investment will cause an increase in investment, resulting in an increase in real GDP. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Macroeconomic Equilibrium Book Section: Consumption and Investment Schedules 12. If real interest rates were to increase, (A) investment would increase, but real GDP would decrease (B) investment would decrease, but real GDP would increase (C) investment would remain constant, but real GDP would increase (D) investment would remain constant, but real GDP would decrease (E) investment would decrease and real GDP would decrease (E) An increase in the real interest rate will cause a decrease in investment, resulting in a decrease in real GDP. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Macroeconomic Equilibrium Book Section: Consumption and Investment Schedules 13. If unplanned inventories are suddenly decreasing, the economy faces (A) an inflationary gap with demand-pull inflation (B) an inflationary gap with cost-push inflation (C) a recessionary gap with cyclical unemployment (D) a recessionary gap with frictional unemployment (E) a recessionary gap with structural unemployment (A) If unplanned inventories are decreasing, the economy is in the short-run position with expenditures greater than potential output (full-employment GDP). The economy will face an inflationary gap and demand-pull inflation. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Macroeconomic Equilibrium Book Section: No Unplanned Changes in Inventories 14. At full-employment output, a nation is operating at its potential real GDP output of $510 billion. The marginal propensity to consume is 0.75. Suddenly, the economy faces an inflationary expenditure gap of $12 billion. If there is no government intervention, in the long run (A) the economy will expand to a new full-employment output of $558 billion (B) the economy will experience no increase in full-employment output but will experience inflation (C) nominal GDP will be less than real GDP (D) both nominal and real GDP will increase (E) frictional and structural unemployment will increase (B) In the long run, the economy cannot produce more than the potential real GDP output of $510 billion. However, because expenditures have increased beyond what the economy can sustain in the long run (inflationary gap), inflation will occur, but real output will remain at $510 billion. Difficulty: Hard Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Short and Long Run Book Section: Inflationary Expenditure Gap 15. The tax multiplier is equal to (A) 1 (B) MPS/MPC (C) MPC/MPS (D) APS/APC (E) APC/APS (C) The tax multiplier will be MPC x the spending multiplier (1/MPS), or MPC/MPS. A change in personal income taxes will change both consumption and savings, but it will change consumption by less than the change in taxes. While disposable income will change by the full amount of the change in taxes, consumption will change by the marginal propensity to consume times the change in taxes. Difficulty: Medium Style: Factual AP Economics Curricular Requirement Macroeconomics: Multiplier and Crowding-Out Effects Book Section: Recessionary Expenditure Gap 16. The marginal propensity to consume is 0.75 and the economy is operating at full-employment real GDP at $510 billion. If a $20 billion personal consumption increase is matched by an equal increase in personal taxes, long-run real GDP will (A) remain unchanged (B) increase by $20 billion (C) increase by $26.67 billion (D) increase by $60 billion (E) increase by $80 billion (A) Nominal GDP will increase by $20 billion but real GDP will remain unchanged at $510 billion. Difficulty: Medium Style: Applied AP Economics Curricular Requirement Macroeconomics: Macroeconomic Equilibrium Book Section: Taxation and Equilibrium GDP 17. If the economy is at full-employment output and personal taxes decrease, which of the following will be true in the long run? Disposable Aggregate Equilibrium Income Consumption Saving Expenditures Real GDP (A) Increases Increases Increases Increases Increases (B) Increases Increases Increases Increases Unchanged (C) Increases Increases Increases Unchanged Unchanged (D) Unchanged Increases Decreases Increases Increases (E) Unchanged Increases Increases Unchanged Unchanged (B) While a decrease in personal taxes will increase disposable income, consumption, saving, and aggregate expenditures, the long-run equilibrium level of real GDP will remain unchanged because the economy is at full-employment prior to the decrease in personal taxes. Difficulty: Medium Style: Applied AP Economics Curricular Requirement Macroeconomics: Short and Long Run Book Section: Taxation and Equilibrium GDP 18. If the economy is operating below full-employment output, an increase in exports will result in an increase in the equilibrium level of real GDP with (A) a decrease in structural unemployment (B) a decrease in frictional unemployment (C) a decrease in cyclical unemployment (D) a decrease in seasonal unemployment (E) an increase in underemployment (C) The economy is in a cyclical downturn, which results in cyclical unemployment. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Actual versus Full-Employment Output Book Section: Net Exports and Equilibrium GDP 19. If there is a recessionary gap, (A) actual GDP minus full-employment GDP is positive (B) full-employment GDP minus actual GDP is negative (C) actual GDP minus full-employment GDP is negative (D) full-employment GDP is less than actual GDP (E) actual GDP minus full-employment GDP is zero (C) If there is a recessionary gap, actual GDP is less than full-employment GDP. Therefore, actual GDP minus full-employment GDP will be negative. Difficulty: Easy Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Actual versus Full-Employment Output Book Section: Recessionary Expenditure Gap 20. A country’s exports are decreasing while its imports are increasing, resulting in a negative balance of trade (trade deficit). This country’s economy will (A) expand and employment will increase (B) expand and employment will decrease (C) contract and employment will increase (D) contract and employment will be unaffected (E) contract and employment will decrease (E) A reduction in exports and an increase in imports will contract the economy, reduce real GDP, and decrease employment. Difficulty: Medium Style: Applied AP Economics Curricular Requirement Macroeconomics: Real Output and Price Level Book Section: Net Exports and Equilibrium GDP 21. Classical theory failed in the Great Depression because (A) firms laid off their workers (B) consumers continued to increase consumption (C) government increased spending too quickly (D) firms were unable or unwilling to lower prices (E) government increased spending too slowly (D) Classical theory held that when aggregate demand fell, prices would fall in order to reclaim demand and automatically correct economic malfunctions. Difficulty: Medium Style: Factual AP Economics Curricular Requirement Macroeconomics: Stabilization Policies Book Section: Assumptions and Simplifications 22. The economic theory that calls for the use of taxes and government spending to correct economic instability is (A) Classical theory (B) Keynesian theory (C) Monetarist theory (D) Supply-Side theory (E) Marxist theory (B) Keynesian theory advocated the use of both fiscal and monetary policy, calling on government to intervene to stabilize the economy. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Macroeconomics: Fiscal and Monetary Policies Book Section: Recessionary Expenditure Gap 23. An increase in disposable income will cause which of the following changes in the economy? Marginal Propensity to Consume Multiplier Real GDP (A) Increase Increase Increase (B) No change No change No change (C) Increase No change Increase (D) No change No change Increase (E) Increase Increase No change (D) An increase in disposable income will change the amount of consumption, changing the real GDP. But because a change in disposable income does not change MPC, the multiplier does not change. Difficulty: Medium Style: Application AP Economics Curricular Requirement Macroeconomics: Multiplier and Crowding-Out Effects Book Section: Changes in Equilibrium GDP and the Multiplier 24. Assume that consumers in a nation reduce their marginal propensity to save from 0.25 to 0.2 though their personal incomes initially do not change. How will this change in MPS affect the economy? Marginal Propensity to Consume Multiplier Real GDP (A) Increase Increase Increase (B) No change No change No change (C) Increase No change Increase (D) No change No change Increase (E) Increase Increase No change (A) A reduction in MPS increases the MPC and the multiplier. Even though initial incomes did not change, because they faced a larger multiplier, real GDP would increase. Difficulty: Medium Style: Application AP Economics Curricular Requirement Macroeconomics: Multiplier and Crowding-Out Effects Book Section: Changes in Equilibrium GDP and the Multiplier 25. Classical theory relied in part on Say’s law, which stated (A) inflation results from too much money chasing too few goods (B) supply creates its own demand (C) in the long run, we’re all dead (D) inflation is always and everywhere a monetary phenomenon (E) from each according to his abilities, to each according to his needs (B) Say’s law held the position that if production increases, income will be generated that will allow consumers to buy the additional output. Difficulty: Medium Style: Factual AP Economics Curricular Requirement Macroeconomics: Stabilization Policies Book Section: Say’s Law, the Great Depression, and Keynes Free-Response Questions 1. Assume the United States economy is producing at full-employment output, the government has a balanced budget, and imports and exports are balanced. (a) Now assume that because of a significant increase in interest rates, firms change their level of investment. (i) Explain whether investment will increase or decrease. (ii) Explain how the change in investment will affect real GDP. (iii) Explain how the change in real GDP will affect employment. (b) Identify one fiscal policy action the government could take to restore the economy to full-employment GDP. 2. Assume the United States economy is producing at full-employment output, the government has a balanced budget, and imports and exports are balanced. (a) Now assume that Canada, a major buyer of U.S. exports, goes into a recession. As a result, current GDP falls to $100 billion less than full-employment GDP and the marginal propensity to consume is 0.6. (i) Explain the reason Canada's recession affects U.S. GDP. (ii) Identify the formula for the spending multiplier. (iii) Calculate the spending multiplier. (iv) Calculate the amount by which government spending must increase to return current GDP to full-employment GDP. (b) Which would have a larger impact on real GDP: an increase in government spending or a decrease in taxes? Explain. Free-Response Explanations 1. 7 points (6 + 1) (a) 6 points: 1 point is earned for stating that investment will decrease. 1 point is earned for explaining that because of the higher interest rate, the cost of the investment is now greater than the expected return on the investment. 1 point is earned for stating that real GDP will decrease. 1 point is earned for explaining that investment is one of the components of real GDP (C + I + G + X - M), so if investment falls, real GDP falls. 1 point is earned for stating that employment will decrease. 1 point is earned for explaining that as output falls, fewer workers are needed to produce that output, so employment falls. (b) 1 point: 1 point is earned for identifying either an increase in government spending or a decrease in taxes. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Macroeconomic Equilibrium Book Section: Consumption and Investment Schedules 2. 6 points (4 + 2) (a) 4 points: 1 point is earned for explaining that as Canadian incomes fall, their demand for U.S. exports falls, reducing U.S. real GDP. 1 point is earned for identifying the U.S. spending multiplier as 1 / MPS. 1 point is earned for calculating the spending multiplier as 2.5 (1 / 0.4). 1 point is earned for calculating the minimum increase in government spending as $40 billion ($100 billion / 2.5). (b) 2 points: 1 point is earned for stating that an increase in government spending has a larger impact on real GDP. 1 point is earned for explaining that if taxes are reduced, consumers will save part of the tax reduction rather than spending all of it in the economy. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Demand-Side Effects Book Section: Equilibrium versus Full-Employment GDP