The multiplier model
Congratulations! You have been
appointed as economic policy advisor to the United States. You are told that
the economy is significantly below its potential output and the following is
projected for next year: world output will fall significantly and the price of
oil will rise significantly.
a. What is meant by potential
output?
b. What will happen to the price
level and output?
c. What policy might you suggest to
the government?
2.
a. Marginal propensity to expend is
0.5 and there is a recessionary gap of $200. What fiscal policy would you
recommend?
b. Why does cutting taxes by $100
have a smaller effect in GDP than increasing expenditures by $100?
3.
a. Suppose imports were a function
of disposable income instead of income. What would be the new multiplier? How
does it compare with the multiplier when imports were a function of income?
b. Explain why making taxes and
imports endogenous reduces the multiplier?
4.
State how the following information
changes the slope of the AD curve.
a. The effect of price level
changes on autonomous expenditures is reduced.
b. The size of the multiplier
increases.
c. Autonomous expenditures increase
by $20
d. Falls in the price level disrupt
financial markets which offset the normally assumed effects of a change in the
price level.
5.
a. Your employer offers you a
choice of two bonus packages: $1,400 today or $2,000 five years from now.
Assuming a 6 percent rate of interest, which is the better value? Assuming an
interest rate of 10 percent, which is the better value?
b. Suppose the price of a one-year
10 percent coupon bond with a $100 face value of $98. Are market interest rates
likely to be above or below 10 percent? Explain. What is the bond’s yield or
return? If market interest rates fell, what would happen to the price of the
bond?
