Chapter 10 – Basic Macroeconomic Relationships
10-1
CHAPTER 10
Basic Macroeconomic Relationships
A. Short-Answer, Essays, and Problems
1. What are the relationships among consumption, saving, and disposable income?
2. Define the consumption schedule.
3. Describe the saving schedule.
4. Explain how consumption and saving are related to disposable income in the aggregate expenditures model.
5. Fill in the table below. Describe your result.
Chapter 10 – Basic Macroeconomic Relationships
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Disposable Income Consumption Saving
$200 $210 $_____
$_____ $220 $0
$_____ $230 $10
$260 $_____ $20
$280 $_____ $30
$300 $260 $_____
6. Complete the following table assuming that (a) MPS = 1/5, (b) there is no government and all saving is
personal saving.
Chapter 10 – Basic Macroeconomic Relationships
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Level of output and income
Consumption
Saving
$250 $260 $_____
275 _____ _____
300 _____ _____
325 _____ _____
350 _____ _____
375 _____ _____
400 _____ _____
7. Complete the following table assuming that (a) MPS = 1/3, (b) there is no government and all saving is
personal saving.
Chapter 10 – Basic Macroeconomic Relationships
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Level of output and income
Consumption
Saving
$100 $120 $_____
130 _____ _____
160 _____ _____
190 _____ _____
220 _____ _____
250 _____ _____
8. Differentiate between the average propensity to consume and the marginal propensity to consume.
9. What are the marginal propensity to consume (MPC) and marginal propensity to save (MPS)? How are the
two concepts related? How are the two concepts related to the consumption and saving functions?
10. If you know the marginal propensity to consume you can determine the marginal propensity to save. How
is that possible?
11. If you know the average propensity to consume you can determine the average propensity to save. How is
that possible?
12. Suppose a family’s annual disposable income is $8000 of which it saves $2000.
(a) What is their APC?
(b) If their income rises to $10,000 and they plan to save $2800, what are their MPS and MPC?
(c) Did the family’s APC rise or fall with their increase in income?
13. Complete the accompanying table.
Chapter 10 – Basic Macroeconomic Relationships
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Level of output and income
(GDP = DI)
Consumption
Saving
APC
APS
MPC
MPS
$100 $_____ −$5 _____ _____ _____ _____
125 _____ 0 _____ _____ _____ _____
150 _____ 5 _____ _____ _____ _____
175 _____ 10 _____ _____ _____ _____
200 _____ 15 _____ _____ _____ _____
225 _____ 20 _____ _____ _____ _____
250 _____ 25 _____ _____ _____ _____
275 _____ 30 _____ _____ _____ _____
300 _____ 35 _____ _____ _____ _____
(a) What is the break-even level of income? How is it possible for households to dissave at very low
income levels?
(b) If the proportion of total income consumed decreases and the proportion saved increases as income
rises, explain how the MPC and MPS can be constant at various levels of income.
14. Complete the accompanying table.
Chapter 10 – Basic Macroeconomic Relationships
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Level of output and income
(GDP = DI)
Consumption
Saving
APC
APS
MPC
MPS
$480 $_____ −$8 _____ _____ _____ _____
520 _____ 0 _____ _____ _____ _____
560 _____ 8 _____ _____ _____ _____
600 _____ 16 _____ _____ _____ _____
640 _____ 24 _____ _____ _____ _____
680 _____ 32 _____ _____ _____ _____
720 _____ 40 _____ _____ _____ _____
760 _____ 48 _____ _____ _____ _____
800 _____ 56 _____ _____ _____ _____
(a) Using the below graphs, show the consumption and saving schedules graphically.
(b) Locate the break-even level of income. How is it possible for households to dissave at very low
income levels?
(c) If the proportion of total income consumed decreases and the proportion saved increases as income
rises, explain both verbally and graphically how the MPC and MPS can be constant at various levels of
income.
15. List four factors that could shift the consumption schedule.
Chapter 10 – Basic Macroeconomic Relationships
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16. Define wealth. What is the effect of increase in wealth on the consumption and saving schedules?
17. How does increased household borrowing affect present and future consumption?
18. Suppose that real interest rates increase. What would be the likely effect on household consumption and
saving?
19. Other things being constant, what will be the effect of each of the following on disposable income (or
GDP)?
(a) An increase in the amount of liquid assets consumers are holding
(b) A sharp rise in stock prices
(c) A rapid upsurge in the rate of technological advance
(d) A sharp increase in the interest rate
Chapter 10 – Basic Macroeconomic Relationships
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20. Other things being constant, what will be the effect of each of the following on consumption and saving
schedules?
(a) Credit card companies increase the interest-free periods on their cards to compete for customers.
(b) Concern grows over rising prices.
(c) A weakening of the housing market lowers home values.
(d) Real interest rates fall.
(e) Congress officially approves the President’s plan for tax cuts.
21. Explain the difference between a movement along the consumption schedule and a shift in the consumption
schedule.
22. Use the graphs below to answer the following questions:
(a) What types of schedules do graphs A and B represent?
(b) If in graph A line A2 shifts to A3 because households consume more and this change is not due to
changing taxes, then in graph B, what would happen to line B2?
(c) If in graph B, line B2 shifts to B1 because households save less, then in graph A, what will happen to
line A2?
(d) In graph A, what has caused the movement from point A to point B on line A2?
(e) If there is a lump-sum tax increase causing line A2 to shift to A1, then in graph B, what will happen to
B2?
23. (Consider This) Use the Great Recession of 2007–2009 to describe the paradox of thrift.
24. Describe the relationship shown by the investment demand curve.
25. Consider the following investment situations.
(a) A local bookseller is considering expanding store space to increase his capacity for books. The rent for
the additional space would cost $3000 per year. The bookseller predicts that the added space will pull
in an additional profit of $4000 per year. The current interest rate is 12%. Should the bookseller
invest in the extra space?
(b) A baker is considering expanding her business by adding an additional oven to her kitchen. The new
oven would cost $700. The baker expects the new oven to bring in additional profits of $800. The
baker can borrow at a nominal interest rate of 15% and the current inflation rate is 4%. Should she
make the investment?
(c) A mechanic is considering expanding his garage. After a strong year last year, the mechanic is able to
finance the expansion from last year’s profits. The expansion itself is expected to cost $11,000. The
mechanic estimates that the additional garage will bring in revenue totaling $12,000. The mechanic is
currently receiving an interest rate of 8% on his saved profits. Should he make the investment?
Chapter 10 – Basic Macroeconomic Relationships
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26. Use the following data to answer the questions.
Expected rate
of return Cumulative amount
of investment (billions)
11% $ 55
10 75
8 90
5 105
3 150
1 190
(a) Explain why this table is essentially an investment demand schedule.
(b) If the interest rate was 8%, how much investment would be undertaken?
(c) Why is there an inverse relationship between the rate of interest and the amount of investment?
27. What is the investment demand curve?
28. List six events that could cause a shift in the investment demand curve.
29. How will the following situations affect the investment demand curve?
(a) A new type of engine is developed that is more fuel efficient.
(b) To lessen the fiscal deficit, Congress increases corporate taxes.
(c) Unplanned inventories rise to new highs.
(d) A firm decides to increase its current inventory levels.
30. Contrast planned and unplanned inventory changes. What effect do these changes have on the investment
demand curve?
31. State four factors that explain why investment spending tends to be unstable.
32. Which is the most volatile component of total spending? What four factors contribute to the volatility of
this component of total spending?
33. Compare the determinants of consumption with investment. Most economists regard investment as being
less stable than consumption. Looking at the determinants of each factor, support this contention.
34. (Consider This) Why did the lowering of real interest rates during the Great Recession not boost
investment spending?
35. Whenever there is change in spending real GDP will change by a multiple of the initial change in spending.
Explain this multiplier effect.
36. Define the multiplier. How is it related to real GDP and the initial change in spending? How can the
multiplier have a negative effect?
37. What are two key facts that serve as the rationale for the multiplier effect?
38. Explain the economic impact of an increase in the multiplier.
39. Consider the effect of the following on the multiplier.
(a) As a recession ends and recovery begins consumers are feeling less cautious about spending.
(b) As the economy moves into an expansion, spending increases.
(c) Uncertainty about national security and political relations abroad causes the public to adjust by saving
more to use in case of an economic downturn worldwide.
Chapter 10 – Basic Macroeconomic Relationships
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40. What is the relationship between the multiplier and the marginal propensities?
41. Describe the relationship between the size of the MPC and the multiplier. How does it compare to the
relationship between the size of the MPS and the multiplier?
42. Calculate the multiplier when the MPC is .5, .75, .90. What is the relationship between MPC and the
multiplier?
43. Calculate the multiplier when the MPS is .5, .25, .10. What is the relationship between MPS and the
multiplier?
44. How large is the actual multiplier?
45. (Last Word) Describe the events “Squaring the Economic Circle” and explain how they illustrate the
multiplier.
Chapter 10 – Basic Macroeconomic Relationships
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B. Answers to Short-Answer, Essays, and Problems
1. What are the relationships among consumption, saving, and disposable income?
550; MA pp. 192-194]
3. Describe the saving schedule.
4. Explain how consumption and saving are related to disposable income in the aggregate expenditures model.
5. Fill in the table below. Describe your result.
Chapter 10 – Basic Macroeconomic Relationships
10–12
Disposable Income Consumption Saving
$200 $210 $_____
$_____ $220 $0
$_____ $230 $10
$260 $_____ $20
$280 $_____ $30
$300 $260 $_____
Chapter 10 – Basic Macroeconomic Relationships
10–13
6. Complete the following table assuming that (a) MPS = 1/5, (b) there is no government and all saving is
personal saving.
Chapter 10 – Basic Macroeconomic Relationships
10–14
Level of output and income
Consumption
Saving
$250 $260 $_____
275 _____ _____
300 _____ _____
325 _____ _____
350 _____ _____
375 _____ _____
400 _____ _____
Chapter 10 – Basic Macroeconomic Relationships
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7. Complete the following table assuming that (a) MPS = 1/3, (b) there is no government and all saving is
personal saving.
Chapter 10 – Basic Macroeconomic Relationships
10–16
Level of output and income
Consumption
Saving
$100 $120 $_____
130 _____ _____
160 _____ _____
190 _____ _____
220 _____ _____
250 _____ _____