Chapter 20
ANSWERS TO QUESTIONS
1. “When the stock market rises, investment spending is increasing.” Is this statement true, false,
or uncertain? Explain your answer.
2. Why is inventory investment counted as part of aggregate spending if it isn’t actually sold to
the final end user?
3. “Since inventories can be costly to hold, firms’ planned inventory investment should be zero,
4. During and in the aftermath of the financial crisis of 2007–2009, planned investment fell
substantially despite significant decreases in the real interest rate. What factors related to
the planned investment function could explain this?
5. If households and firms believe the economy will be in a recession in the future, will this
necessarily cause a recession, or have any impact on output at all?
6. Why do increases in the real interest rate lead to decreases in net exports, and vice versa?
7. Why does equilibrium output increase as the marginal propensity to consume increases?
8. If firms suddenly become more optimistic about the profitability of investment and planned
9. In each of the cases below, what happens to equilibrium output? Briefly explain how it
affects the relevant component(s) of planned spending.
a. The real interest rate rises.
b. The marginal propensity to consume falls.
c. Financial frictions increase.
d. Autonomous consumption decreases.
e. Both taxes and government spending decrease by the same amount.
The decrease in taxes will increase consumption, which has the effect of increasing output.
The decrease in government spending has the effect of reducing equilibrium output.
f. The sensitivity of net exports to changes in the real interest rate decreases.
g. The government provides tax incentives for research and development programs for
firms.
10. Rise. The fall in spending from an increase in taxes is always less than the change in taxes
because the marginal propensity to consume is less than 1. By contrast, autonomous
spending rises one-for-one with a change in autonomous consumer expenditure. If taxes and
autonomous consumer expenditure rise by the same amount, autonomous spending must rise,
and aggregate output also rises.
11. In this case, as interest rates fall, planned investment spending and net export do not change,
12. Companies cut production when their unplanned inventory investment is greater than zero,
costly to store and finance.
13. False. In this case, if actual investment is greater than planned investment, firms are adding
14. In each of the cases below, determine whether the IS curve shifts to the right or left, does not
shift, or is indeterminate in the direction of shift.
a. The real interest rate rises.
c. Financial frictions increase.
d. Autonomous consumption decreases.
e. Both taxes and government spending decrease by the same amount.
f. The sensitivity of net exports to changes in the real interest rate decreases.
g. The government provides tax incentives for research and development programs for
firms.
15. “The fiscal stimulus package of 2009 caused the IS curve to shift to the left, since output
decreased and unemployment increased after the policies were implemented.” Is this
statement true, false, or uncertain? Explain your answer.
16. When the Federal Reserve reduces its policy interest rate, how, if at all, is the IS curve
affected? Briefly explain.
17. Suppose you read that prospects for stronger future economic growth have led the dollar to
strengthen and stock prices to increase.
a. What effect does the strengthened dollar have on the IS curve?
b. What effect does the increase in stock prices have on the IS curve?
autonomous planned investment, as investors become more confident about the future
prospects of the economy. Therefore, we should expect autonomous planned investment
to increase and the IS curve to shift to the right.
c. What is the combined effect of these two events on the IS curve?
ANSWERS TO APPLIED PROBLEMS
18. Calculate the value of the consumption function at each level of income in the table below if
autonomous consumption = 300, taxes = 200, and mpc = 0.9.
Income Y
Disposable Income YD
Consumption C
0
100
200
300
400
500
600
Income Y
Disposable Income YD
Consumption C
0
–200
120
100
–100
210
200
0
300
300
100
390
400
200
480
500
300
600
400
19. Assume that autonomous consumption is $1,625 billion and disposable income is $11,500
billion. Calculate consumption expenditure if an increase of $1,000 in disposable income leads
to an increase of $750 in consumption expenditure.
If an increase of $1,000 in disposable income leads to an increase of $750 in consumption