Ch15 Answer Key, Intro to Economics

Ch15 Answer K= ey, Intro to Economics

1A) AE =3D Y

= AE =3D C + I + G + X – M

= C =3D 600 + 0.75*(Y – T)

= By substituting known values and equations, you should be able to find:

= Y =3D 600 + 0.75*(Y – 400) + 500 + 400

= Y =3D 1200 + 0.75*Y

= 0.25*Y =3D 1200

= Y =3D 4800

1B) The multiplier is : = DY/DG =3D 1/(1-mpc) =3D 1/(1-0.75) =3D 4

= Since we know = DY =3D 5100 – 4800 =3D 300, we can find:

= DY / Multiplier =3D = DG =3D 300/4 =3D 75

1C)

&nbs= p;

1D) The Keynesian Cross is better at illustrating the multiplier effect: The change= in government spending is much bigger than the resulting change in GDP. It doe= s not, however, illustrate the price (and inflation) effects of government policie= s. For this, you need AS/AD.

1E) Multiplier =3D DY/DT =3D -mpc / (1-mpc) =3D -0.75 / (1 – 0.75) =3D 3

= Since we know = DY =3D 5100 – 4800 =3D 300, we can find:

= DY / Multiplier =3D = DT =3D 300/3 =3D 100

2A) If= a recession hits and people start earning lower incomes, their marginal tax r= ates might also be lower. People will then be able to consume a higher proportio= n of their income, which will help mitigate the severity of a recession. Note th= at the slope of the line is (1-t)*mpc.

2B) t =3D 0.25 and mpc =3D 0.80

= DY/DG =3D 1 / (1 – 0.75*0.80) =3D 2.5

2C) t =3D 0.25 and mpc =3D 0.80

= DY/DG =3D 1 / (1 – 0.25*0.80) =3D 1.25

= The multiplier diminishes as tax rates rise. This happens because people have l= ess disposable income that they are able to spend and “recycle” thr= ough the economy.

3= ) When the IMF provides money to bail-out economies that have collapsed, they force countries to embrace a series of strict free-market reforms that they belie= ve are best for promoting long-term economic growth. One such reform includes “getting provincial governments to cut their spending” (or redu= ce government budget deficits). These policies may be appropriate for the long term healthy of the economy, but are the opposite of the prescription offered by Keynesian Economics: Raise G and Cut T during recessions. Thus, the IMF may increase the severity of short-run economic recessions. (Do you see why many people protest the IMF?)

I should reiterate that the IMF’s policies probably do promote long-term growth, but may also make the short-term transition painful.

4) &nb= sp; Monetary Policy has a short inside lag (time to enact a policy) but long outside lag= (time for policy to affect economic conditions). Fiscal policy has a long inside = lag, but short outside lag. Neither policy is necessarily “better” t= han the other. The US usually advocates monetary policy as a stability tool, because compared to = Congress, the Fed is less subject to political pressur= es sometimes at odds with stabilization policy. Some people advocate a complete “hands-off” approach, since the economy should naturally return= to its long run potential, and attempts to intervene may just cause inflation.=

(Note: The efficacy of these tools is also dependent u= pon the exchange rate system in place, but this is FAR beyond the scope of the course).