23) In an economy, the multiplier is 3. If government expenditure increases by $1 million, then
in the short run, the price level ________ and real GDP ________ $3 million.
A) falls; decreases by less than
B) rises; equals
C) rises; increases by less than
D) rises; decreases by less than
24) The government increases its expenditures. The steeper the SAS curve, the ________ will be
the increase in the price level and the ________ will be the increase in real GDP.
A) larger; larger
B) larger; smaller
C) smaller; larger
D) smaller; smaller
25) When the aggregate demand curve shifts, the steeper the SAS curve the ________ will be a
change in the price level and the ________ will be the multiplier.
A) larger; larger
B) larger; smaller
C) smaller; larger
D) smaller; smaller
26) With a steep short-run aggregate supply curve
A) an increase in government expenditure will not have an impact on the price level.
B) fiscal policy will be an effective tool to reduce unemployment without raising prices too
much.
C) an increase in taxes that does not change potential GDP will not decrease real GDP by much.
D) there is a large change in real GDP whenever the price level rises.
27) Taking into account the upward-sloping short-run aggregate supply curve, the short-run
effect of an increase in government expenditure on real GDP is that
A) real GDP increases by more in the short run than in the long run.
B) real GDP increases by the same amount in the short run as in the long run.
C) real GDP increases by less in the short run than in the long run.
D) real GDP does not change in the short run because the price level increases.
28) Because of changes in the ________, the long-run effect of a $10 increase in investment on
real GDP equals ________.
A) interest rate; zero
B) interest rate; $10
C) money wage rate and price level; zero
D) money wage rate and price level; $10
29) The size of the multiplier
A) is unaffected by the amount of time that elapses.
B) increases in the long run.
C) decreases in the long run.
D) is constant in the long run.
30) The multiplier effect is smallest
A) in the long run.
B) in the short run.
C) when the price level is fixed.
D) when the economy is in a recession.
31) The short-run multiplier is equal to 3, real GDP equals potential GDP of $8,000, and the
price level is equal to 100. Suppose that government expenditure decreases by $200. The long-
run effect of the decrease in government expenditure changes real GDP by
A) a decrease of 600.
B) an increase of 600.
C) nothing; that is, in the long run real GDP equals $8,000.
D) a decrease of $200 because in the long-run, the multiplier is 1.
32) After an increase in autonomous spending, in the long run changes in the price level
A) will make the AE curve steeper.
B) will make the AE curve flatter.
C) will reduce the effect of the multiplier.
D) will not affect the multiplier.
33) In the long run, the multiplier
A) is greater than 1 because of the position and slope of the SAS curve.
B) is twice the short-run multiplier.
C) is zero.
D) depends on the slope of the AD curve.
34) When the economy is at full employment and investment increases, in the long run the price
level will ________ and, if potential GDP does not change, in the long run real GDP will
________.
A) increase; increase
B) decrease; not change
C) decrease; decrease
D) increase; not change
35) A fall in the price level shifts the AE curve ________ and ________ equilibrium expenditure.
A) upward; increases
B) upward; decreases
C) downward; increases
D) downward; decreases
36) If the multiplier is 4.0 and investment decreases by $2.5 billion, the AD curve
A) shifts rightward by $10 billion.
B) shifts rightward by less than $10 billion.
C) shifts leftward by $10 billion.
D) shifts leftward by more than $30 billion.
37) The multiplier is 2.5 and the SAS curve is upward sloping. Investment increases by $20
billion. In the short run, equilibrium real GDP will
A) increase by $50 billion.
B) increase by less than $50 billion.
C) decrease by $50 billion.
D) decrease by less than $50 billion.
38) The multiplier is 5.0 and autonomous expenditure increases by $30 billion. If potential real
GDP is unaffected, in the long run, equilibrium real GDP will
A) increase by $50 billion.
B) increase by more than $50 billion.
C) increase by less than $50 billion.
D) not change.
105
5 Mathematical Note: The Algebra of the Keynesian Model
1) Suppose the consumption function is given by the equation C = 100 + 0.8YD, where YD is
disposable income. What is the marginal propensity to consume?
A) 0.2
B) 0.8
C) 2.0
D) 100
2) Suppose the consumption function is given by the equation C = 100 + 0.8YD, where YD is
disposable income. What is the marginal propensity to save?
A) 0.2
B) 0.8
C) 2.0
D) 100
3) Suppose the consumption function is given by the equation C = 100 + 0.8YD, where YD is
disposable income. What is the multiplier in this economy?
A) 5
B) 2
C) 0.8
D) 0.2
6 News Based Questions
1) In 2007, investment in France increased by 7 billion euros. Assume the price level was
constant, the multiplier was 5 and the economy was at full employment. As a result, equilibrium
expenditure
A) increased by 35 billion euros.
B) increased by 1.4 billion euros.
C) decreased by 35 billion euros.
D) decreased by .71 billion euros.
2) In 2007, investment in France increased by 7 billion euros, consumption increased by 4 billion
euros and government spending increased by 1.5 billion euros. Assume the price level was
constant and the economy was at full employment. As a result, suppose that equilibrium
expenditure increased by 21 billion euros. In this example, ________ is the induced expenditure
and ________ is autonomous expenditure.
A) consumption; government spending
B) investment; consumption
C) investment; government spending
D) government spending; equilibrium expenditure
3) “Few if any economists anticipated the extent of the inventory adjustment… Production
cutbacks have been much greater than expected. Those cuts have weakened the industrial sector
considerably.” As a result of these changes, the U.S. government lowered its estimate of fourth-
quarter growth in real GDP.
www.businessweek.com 3/12/2007
The article suggests that ________.
A) planned expenditures exceeded real GDP in 2006.
B) real GDP exceeded planned expenditures in 2006.
C) the AE curve shifted upward in 2007.
D) the AD curve shifted rightward in 2007.
4) The software and related services sector has a multiplier effect on the Indian economy with
every one-rupee input spent by the” information technology sector” producing an increase in real
GDP by two rupees.
www.ft.com, 2/28/2008
According to the story, if ________ in the software and related services sector increases by $15
billion, real GDP will increase by ________.
A) investment; $30 billion.
B) consumption; $30 billion.
C) consumption; $2 billion.
D) investment; $2 billion.
5) Mauritius, an island off the coast of Africa, competes with other countries producing goods
with low-skilled labor. In 2006, it was reported that its “… factories have been exposed to …
competition from China, India and other Asian mass producers.” As a result, “the main export
industry has seen a 30 per cent reduction in volume …”
www.ft.com, 3/13/2006
The story describes
A) a decrease in autonomous expenditure.
B) a decrease in induced expenditure.
C) an unplanned decrease in inventories.
D) an increase in equilibrium expenditure.
6) Mauritius, an island off the coast of Africa, competes with other countries producing goods
with low-skilled labor. In 2006, it was reported that …”its clothing factories have been exposed
to frontal competition from China, India and other Asian mass producers.” As a result, “the main
export industry has seen a 30 per cent reduction in volume …”
www.ft.com, 3/13/2006
Suppose real GDP is $14 billion, exports total $2 billion and the multiplier is 4. If exports
decline by $600,000,000, real GDP in Mauritius will
A) increase by $2.4 billion
B) decrease by $2.4 billion.
C) decrease by $8 billion.
D) increase by $4 billion.
7) In an article regarding Bangladesh’s economy, the author suggests that the government
…”[g]ive double tax breaks on investment dollars. Give a tax break to R&D [research and
development]. Give a tax break on donations to educational institutions.”
www.groundreport.com, March 24, 2008
The increase in investment is considered ________ and will generate a larger increase in
________.
A) equilibrium spending; autonomous expenditure
B) autonomous expenditure; induced expenditure
C) induced expenditure; autonomous expenditure
D) autonomous expenditure; multiplier spending.
8) In an article regarding Bangladesh’s economy, the author suggests that the government
…”[g]ive double tax breaks on investment dollars. Give a tax break to R&D [research and
development]. Give a tax break on donations to educational institutions.”
www.groundreport.com, March 24, 2008
Suppose the multiplier in Bangladesh is 2. If the government enacts the proposed policies and
________, aggregate expenditure ________ in the short run.
A) induced expenditure increases by $5 billion; increases by $10 billion.
B) autonomous expenditure decreases by $10; decreases by $5 billion.
C) equilibrium expenditure increases by $8 billion; increases by $16 billion.
D) autonomous expenditure increases by $10 billion; increases by $20 billion.
9) In an article regarding Bangladesh’s economy, the author suggests that the government
…”[g]ive double tax breaks on investment dollars. Give a tax break to R&D [research and
development]. Give a tax break on donations to educational institutions.”
www.groundreport.com, March 24, 2008
Suppose the multiplier in Bangladesh is 2. As a result of enacting the proposed policies, which
of the following describe possible outcomes in the short run?
I. an $20 billion increase in investment will increase aggregate expenditure by $40 billion.
II. the AE curve will shift upward.
III. there will be an unplanned increase in inventories.
A) I,II and III
B) I and II only
C) I and III only
D) II and III only
10) In the third quarter of 2008, investment in the U.S. totaled $1.4 trillion and in 2007,
investment was $1.3 trillion. The change in investment
A) is a change in autonomous expenditure.
B) is a change in equilibrium expenditure.
C) is a change in induced expenditure.
D) will increase the multiplier.
11) An estimate of the MPC in the U.S. is 0.90.
Paul Krugman, the 2008 Nobel Prize winner in economics, stated, “… you’d be hard pressed to
argue for an overall multiplier as high as 2.”
www.nytimes.com, 11/10/2008
What factors could explain the difference between the MPC and Krugman’s estimate of the
multiplier?
A) exports and investment
B) investment and imports
C) imports and taxes
D) taxes and investment
12) In the third quarter of 2008, investment in the U.S. totaled $1.4 trillion and in 2007,
investment was $1.3 trillion. In addition, third quarter real GDP was $11 trillion. Suppose the
MPC in the U.S. is 0.80.
Ignoring the effects of imports and taxes, the multiplier is ________ and the change in
investment will decrease equilibrium expenditure by ________.
A) 2; $1 trillion
B) 5; $1 trillion
C) 2; $200 million
D) 5; $500 million
13) In an article regarding Bangladesh’s economy, the author suggests that the government
…”[g]ive double tax breaks on investment dollars. Give tax break to R&D [research and
development]. Give tax break on donations to educational institutions.”
www.groundreport.com, March 24, 2008
As a result of enacting the policies, the AE curve will shift ________ and the AD curve will shift
________.
A) upward; leftward
B) upward; rightward
C) downward; rightward
D) downward; leftward
14) Mauritius, an island off the coast of Africa, competes with other countries producing goods
with low-skilled labor. In 2006, it was reported that its “… factories have been exposed to …
competition from China, India and other Asian mass producers.” As a result, “the main export
industry has seen a 30 per cent reduction in volume…”
www.ft.com, 3/13/2006
The decrease in exports represents a change in ________ expenditure and will cause ________.
A) induced; a downward shift in the AE curve and a leftward shift in the AD curve
B) autonomous; a downward shift in the AE curve and a leftward shift in the AD curve
C) induced; an upward shift in the AE curve and a leftward shift in the AD curve
D) autonomous; a downward shift in the AE curve and a rightward shift in the AD curve
15) Mauritius, an island off the coast of Africa, competes with other countries producing goods
with low-skilled labor. In 2006, it was reported that its “… factories have been exposed to …
competition from China, India and other Asian mass producers.” As a result, “the main export
industry has seen a 30 per cent reduction in volume …”
www.ft.com, 3/13/2006
The decrease in exports will cause ________ and the price level will ________.
A) a downward shift in the AE curve; decrease as the AD curve shifts leftward in the short run
B) an upward shift in the AE curve; increase as the AD curve shifts rightward in the long run
C) a leftward shift in the AD curve; fall in the short run and rise in the long run
D) a leftward shift in the AD curve; rise in the long run as goods become more scarce
16) In 2007, investment in France increased by 7 billion euros. Which of following occurs?
I. an upward shift in the AE curve
II. a leftward shift in the AD curve
III. an increase in the price level and real GDP in the short run
IV. an increase in the price level and no change in real GDP in the long run
A) I, II, III and IV
B) I and III only
C) I, III and IV only
D) III and iv only
17) “The global financial crisis has had a considerable impact on China’s export growth, which
will continue to show weakness with recession in the U.S. and Europe,” said a report by JP
Morgan & Co.
www.money.cnn.com, 11/11/2008
If Chinese exports continue to decline, the AE curve will shift ________, the price level will
________ in the short run and real GDP will ________ in the short run.
A) upward; decrease; decrease
B) downward; decrease; decrease
C) upward; decrease; not change
D) downward; decrease; not change
18) “The global financial crisis has had a considerable impact on China’s export growth, which
will continue to show weakness with recession in the U.S. and Europe,” said a report by JP
Morgan & Co.
www.money.cnn.com, 11/11/2008
If Chinese exports continue to decline, the AE curve will shift ________, the price level will
________ in the long run and real GDP will ________ in the long run.
A) downward; decrease; not change
B) downward; decrease; decrease
C) decrease; not change; not change
D) upward; decrease; not change
7 Essay Questions
1) List the four components of aggregate expenditure. Explain the two-way link with real GDP.
2) What is the consumption function? What factor leads to a movement along the consumption
function?
3) Please explain the relationship between consumption, disposable income and saving.
4) What is the difference between movements along the consumption function and shifts in the
consumption function? What factor or factors lead to movements along the consumption function
and what factor or factors lead to shifts in the consumption function?
5) List and explain factors that influence consumption expenditure.
6) How is it possible for consumption expenditure to be positive even when disposable income is
zero?
7) What is the marginal propensity to consume? Why it is an important concept?
8) What is the marginal propensity to consume? Can the marginal propensity to consume be
greater than 1?
9) What does the marginal propensity to consume measure and how is it related to the
consumption function?
10) What is the relationship between U.S. real GDP and U.S. imports?
11) Discuss the link between real GDP and imports.
12) What is the difference between induced and autonomous expenditure? Which components of
aggregate expenditure fall under which category?
13) Define induced expenditure and autonomous expenditure. Which expenditure items are
induced expenditure and which are autonomous expenditure?
14) List the components of aggregate expenditure and describe how each of them change as real
GDP increases.
15) “Similar to imports, U.S. exports depend on the level of U.S. real GDP so that if real GDP
increases, U.S. exports increase.” Explain whether the previous sentence is correct or incorrect.
16) “Aggregate planned expenditure is the sum of planned consumption expenditure, investment,
government expenditure on goods and services, and exports minus imports.” Is the previous
statement correct or incorrect?
17) Explain the relationships between real GDP, aggregate planned expenditure, induced
expenditure, and unplanned investment.
18) At the equilibrium level of aggregate expenditure, what does aggregate planned expenditure
equal? What happens at other levels of real GDP to bring about an equilibrium?
19) “If aggregate planned expenditure exceeds real GDP, then real GDP will increase.” Explain
whether the previous sentence is correct or incorrect.
20) What is unplanned investment? How does it occur?
21) If real GDP exceeds aggregate planned expenditure, what happens to firm’s unplanned
inventories?
22) If unplanned inventory changes are positive, what is the relationship between aggregate
planned expenditure and real GDP?
23) How do firms respond to unplanned inventory changes? What is the effect on their
production and GDP?
24) Explain the relationship between real GDP and aggregate planned expenditure, AE. What
change to inventories takes place when the two are not equal?
25) Does aggregate planned expenditure always equal real GDP?
26) Suppose that firms find that their inventories are less than planned. In this case, what is the
initial relationship between aggregate planned expenditure and real GDP? Using the aggregate
expenditure model, what adjustments, if any, take place?
27) How does the economy adjust so that aggregate planned expenditure equals real GDP?
28) A country reports that it has an unplanned inventory increase of $1.0 trillion. Discuss how
the economy adjusts until it reaches an unplanned inventory change of $0.0 trillion.
29) Explain the basic idea of the expenditure multiplier and the role consumers play in
determining its magnitude.