Chapter Questions

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NLQRA2016

Economics

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Answer the following from the Problems Appendix in the back of your textbook on pp. 330-332,

  • Chapter 9: Questions 1, 4, and 9
  • Chapter 10: Questions 3, 5, and 6

Your completed Homework assignment should be at least three to four pages in length. All sources used, including the textbook, must be referenced; paraphrased and quoted material must have accompanying citations. All references and citations used must be in APA style.

Textbook: McEachern, W. A. (2015). ECON macroeconomics (4th ed.). Stamford, CT: Cengage Learning.

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UNIT V STUDY GUIDE Aggregate Expenditure and Aggregate Demand Course Learning Outcomes for Unit V Upon completion of this unit, students should be able to: 5. Construct the aggregate expenditure and demand model of the macro economy. Reading Assignment Chapter 9: Aggregate Expenditure and Aggregate Demand Chapter 10: Aggregate Supply Unit Lesson Savings Rates in China: Why the Big Difference, and What are the Implications? In our lesson for Unit V, we study aggregate demand. Have you considered the rate of savings for various countries and the possible implications? After 20 years of going down, the personal saving rate in the United States has increased from the start of the latest “recession,” and one needs to consider what may happen during the recovery. The “Empirical Analysis of the Saving Rate in the United States” is quoted below: The U.S. saving rate has historically been much lower relative to the saving rate of Japan and the 12 nations that make the Euro-zone. For example, between 2000 and 2004 the Euro-zone countries saved 10.5% of their disposable income while Japanese saved 6% of theirs. The saving rate for the U.S. over the same period was only 3.2%. In fact, it was consumers who carried the U.S. economy out of recession in the 80s and 90s and for over two decades United States was known to be a nation of "shop until you drop." Since the early 1980s U.S. personal saving rate declined steadily from a high of 10.9 percent in 1982 to a low rate of 1.4 percent in 2005. This downward trend represented a dramatic change in the behavior of personal saving rate because during the preceding three decades, the personal saving rate had experienced an upward trend. While in the 1950s the average personal saving rate was 7.94 percent, the 1960s and 1970s had witnessed the average personal rates climb to 8.29 and 9.59 percent, respectively. More recently, however, and especially around the onset of the 2007 recession, dubbed the "Great Recession," personal saving rate seems to have staged a turnaround. It climbed systematically, registering at 2.1, 4.1, 5.9, and 5.7 percent for 2007, 2008, 2009, and 2010 respectively. (Amavati, Adilov, & Dilts, 2013, para. 3) What is even more curious is to examine the savings rate in China over the same time. How might someone explain that the Chinese have had the highest savings rate? These savings rates have attracted much research to explain the possible implications. China has achieved savings in recent years of 50% and before that averaged 40% (Eckaus, 2014). Might you be astounded? Why might the Chinese consumers be saving, while the U.S. consumer is credited for spending its, and much of the world’s, way out of a recession? Often the U.S. is criticized for saving too little collectively, while the Chinese are criticized for spending too little. As one examines aggregate spending, which is opposite of aggregate savings, this means that Chinese consumers have a declining rate of consumption. This is contrary to the stated Chinese government’s wish, as stated by economists and the government, to increase consumption. There is the argument that there is a “forced” savings system in China, as noted by government programs that reward investment by taxation policy and economic structures, such as lending rates that encourage investment and not consumer spending. In China, government retirement programs are set up to reward BBA 2401, Principles of Macroeconomics 1 contribution, and this an indirect savings tool. Another way that savings are encouraged is by GUIDE the nonUNIT x STUDY distribution of corporate profits. Profits are being reinvested and not returned to shareholders. The policy of Title the banking system is to encourage loans for reinvestment and not loans to individuals. Which is better, the low savings rate and high consumption of the U.S., or the low consumption and high savings rate of China? As budding economists, we will let you decide. The key is to become informed and note the various trade-offs that are necessary. Government, with the advice of economists, must decide economic policy that creates the most good for everyone. After leaving this course, be aware of these tradeoffs as you work and as you participate as a voter. References Amavati, H., Adilov, N., & Dilts, D. A. (2013). Empirical analysis of the saving rate in the United States. Journal of Management Policy and Practice, 14(2), 46-53. Retrieved from http://www.nabusinesspress.com/JMPP/SamavatiH_Web14_2_.pdf Eckaus, R. S. (2014). Forced saving in china. The China Quarterly, 217, 180-194. doi:http://dx.doi.org/10.1017/S0305741013001446 Suggested Reading Click here for the Chapter 9 Presentation in PowerPoint form. Click here to access a PDF version of the presentation. Click here for the Chapter 10 Presentation in PowerPoint form. Click here to access a PDF version of the presentation. Learning Activities (Non-Graded) Review the online tutorial below [link to MyCourseTools tutorial of same name], which focuses on specific topics in Unit V. Aggregate Demand https://media.pearsoncmg.com/pcp/pls/pls_mycoursetools/fufillment/mct_1256689785_csu/prin_macro/redire ct_01_pm_l10_t02.html Non-graded Learning Activities are provided to aid students in their course of study. You do not have to submit them. If you have questions, contact your instructor for further guidance and information. BBA 2401, Principles of Macroeconomics 2 Chapter 9 ECON4 William A. McEachern Aggregate Expenditure and Aggregate Demand © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 1 Consumption, C • Consumption – Positive, stable relationship with income – Households and economy – 70% of GDP • Disposable income, DI = C + S – Consumption, C – Saving, S © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 2 Exhibit 1 U.S. Consumption Depends on Disposable Income Consumption is on the vertical axis and disposable income on the horizontal axis. Notice that each axis measures trillions of 2009 dollars. For example, in 2000, identified by the red point, consumption was $8.3 trillion and disposable income $8.9 trillion. There is a clear and direct relationship over time between disposable income and consumption. As disposable income increases, so does consumption. © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 3 Consumption Function, C • Consumption, C – Depends on disposable income – Function of income • C – dependent variable • DI – independent variable • Positive slope © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 4 Exhibit 3 The Consumption Function The consumption function, C, shows the relationship between consumption and disposable income, other things constant. © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 5 Marginal Propensity • Marginal propensity to consume, MPC – Fraction of additional income that is spent • Change in consumption / change in income • Marginal propensity to save, MPS – Fraction of additional income that is saved • Change in saving / change in income • MPC + MPS = 1 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 6 Marginal Propensity • Consumption function – Relationship between consumption and income, other things constant • MPC – The slope of consumption function C MPC  DI © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 7 Marginal Propensity • Saving function – Relationship between saving and income, other things constant • MPS – The slope of saving function S MPS  DI © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 8 Exhibit 3 Marginal Propensities to Consume and to Save Real consumption (trillions of dollars) MPC  C 0.4 4   DI 0.5 5 b ∆C=0.4 a ∆DI=0.5 0 (b) Saving function Real saving (trillions of dollars) (a) Consumption function MPS  S 0.1 1   DI 0.5 5 c 0 d ∆S=0.1 ∆DI=0.5 Real disposable income (trillions of dollars) The slope of the consumption function equals the marginal propensity to consume. For the straight-line consumption function in panel (a), the slope is the same at all levels of income and is given by the change in consumption divided by the change in disposable income that causes it. Thus, the marginal propensity to consume equals ΔC/ Δ DI, or 0.4/0.5=4/5. The slope of the saving function in panel (b) equals the marginal propensity to save, Δ S/ Δ DI, or 0.1/0.5=1/5. Both consumption and disposable income are in real terms. © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 9 Nonincome Determinants of C • Net wealth – Value of all assets minus liabilities • Decrease in net wealth – Spend less • C decreases • C function shifts down – Save more (increase S) © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 10 Exhibit 4 Shifts of the Consumption Function Real consumption C’’ C C’ Real disposable income A downward shift of the consumption function, such as from C to C’, can be caused by a decrease in net wealth, an increase in the price level, an unfavorable change in consumer expectations, or an increase in the interest rate. An upward shift, such as from C to C", can be caused by an increase in net wealth, a decrease in the price level, a favorable change in expectations, or a decrease in the interest rate. © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 11 Nonincome Determinants of C • Changes in price level – Changes in real value of cash and bank accounts – Increase in price level • Decreased purchasing power • Decrease C – Downward shift of C function • Increase S © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 12 Nonincome Determinants of C • Interest rate – Reward for savers – Cost for borrowers – Higher interest rates • Save more • Borrow less • Spend less – Decrease C © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 13 Nonincome Determinants of C • Expectations – Future income increase • Increase C now – Future price level increase • Increase C now – Future interest rate increase • Increase C now © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 14 Investment, I • Gross private domestic investment, I – New physical capital – New housing – Net increases to inventories – 16% of GDP • Firms buy new capital goods – Only if they expect this investment to yield a higher return • Than other possible uses of their funds © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 15 Investment, I • Investment demand curve – Inverse relationship • Quantity of investment demanded • Market interest rate – Other things constant • Business expectations • Optimistic expectations – Investment demand increases © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 16 Exhibit 6 Nominal interest rate (percent) Investment Demand Curve for the Economy 10 8 6 D 0 0.9 1.0 1.1 The investment demand curve for the economy sums the investment demanded by each firm at each interest rate. At lower interest rates, more investment projects become profitable for individual firms, so total investment in the economy increases. Investment (trillions of dollars) © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 17 Investment Function • Investment decision – Forward looking • Investment function – Relationship between the amount businesses plan to invest • And the economy’s income (DI) • Other things constant – Autonomous (independent) © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 18 Nonincome Determinants of I • Market interest rate increases – Investment decreases – Downward shift of I function • Business expectations – optimistic – Investment increases – Upward shift of I function © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 19 Exhibit 8 Annual Percentage Change in U.S. Real GDP, Consumption, and Investment Investment varies much more year-toyear than consumption does and accounts for nearly all the variability in real GDP. This is why economic forecasters pay special attention to the business outlook and investment plans. © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 20 Government Purchases, G • Government purchases, G – Government purchases of goods and services – 19% of GDP • Most by state and local governments © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 21 Government Purchases, G • Government purchase function, G – Relationship between government purchases • And the economy’s income, other things constant – Autonomous – Increase in government purchases • Upward shift of G function © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 22 Government • Government outlays – Government purchases, G – Transfer payments, TP • Outright grants from government to households • Vary inversely with income – Taxes, T • Vary directly with income • Net taxes = T-TP, autonomous of income © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 23 Net Exports, X-M • Net exports = Exports – Imports = X – M • Net exports function – Income increases: imports increase – Assumption: Autonomous of income – If M>X: Net exports < 0 – If X>M: Net exports > 0 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 24 Net Exports, X-M • Nonincome determinants of net exports – Price level (US and foreign) – Interest rates (US and foreign) – Foreign income – Exchange rate © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 25 Exhibit 9 Net exports (billions of dollars) Net Export Function 0 -380 2.0 4.0 6.0 8.0 10.0 12.0 14.0 Real disposable income (trillions of dollars) X’’-M’’ -400 X-M -420 X’-M’ Net exports here are assumed to be independent of disposable income, as shown by the horizontal lines. X-M is the net export function when autonomous net exports equal $400 billion. An increase in the value of the dollar relative to other currencies would decrease net exports at each level of income, as shown by the shift down to X‘-M'. A decrease in the value of the dollar would increase net exports at each level of income, as shown by the shift up to X“-M". © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 26 Composition of AE • Aggregate expenditure, AE – AE = C + I + G + (X - M) • Consumption, C – Stable – Long term trend: increase • Investment, I – Fluctuates © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 27 Composition of AE • Aggregate expenditure, AE – AE = C + I + G + (X - M) • Government purchase, G – Long-term trend: declined • Net exports, X-M – Last decade: -5% of GDP © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 28 Deriving GDP Demanded for a Given Price Level © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 29 Simple Spending Multiplier • Increased spending: AE line shifts upward – Round one • Spending > output • Unplanned reduction in inventories • Expand production • Increased income © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 30 Simple Spending Multiplier • Increased spending: AE line shifts upward – Round two • Increased spending and saving • Increased output • Increased income – Round three and beyond • Increased spending and saving • Increased output • Increased income • … as long as spending exceeds output © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 31 The Aggregate Demand Curve • Each price level – Unique AE line • Yields a unique real GDP demanded • Changing the price level – Different real GDP demanded © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 32 The Aggregate Demand Curve • Higher price level – Decreased C – Higher interest rate – Decreased I – Decreased (X-M) – Reduced aggregate spending • AE shifts down – Decrease real GDP demanded © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 33 The Aggregate Demand Curve • Lower price level – Increase: C, I, (X-M) – Increased aggregate spending – AE line shifts up – Increase real GDP demanded • Aggregate demand curve – Various price levels – Quantities of real GDP demanded © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 34 Exhibit 4 Aggregate expenditure (trillions of dollars) Changing the Price Level to Find the Aggregate Demand Curve 0 Price level 120 110 100 0 AE” (P=100) At the initial price level of 110, the aggregate expenditure line is AE, which e’’ AE (P=110) identifies real GDP demanded of $14.0 trillion. This combination of a price level AE’ (P=120) of 110 and a real GDP demanded of e $14.0 trillion determines one combination (point e) on the aggregate demand curve in panel (b). At the higher price level of e’ 120, the aggregate expenditure line shifts down to AE’, and real GDP demanded falls to $13.5 trillion. This 45° price-quantity combination is identified as point e’ in panel (b). At the lower price Real GDP 13.5 14.0 14.5 level of 100, the aggregate expenditure (trillions of dollars) line shifts up to AE”, which increases real GDP demanded. This combination is e’ plotted as point e” in panel (b). Connecting points e, e’, and e” in panel e (b) yields the downward-sloping e’’ aggregate demand curve AD, which shows the inverse relation between the AD price level and real GDP demanded. 13.5 14.0 14.5 Real GDP (trillions of dollars) © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 35 The Aggregate Demand Curve • A given price level – AE line – relationship between • Spending plans and income (real GDP) • Change in price level – Shifts AE line – Changes real GDP demanded – Movement along AD curve • A given price level – For changes in spending: shift AD curve © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 36 Exhibit Aggregate expenditure (trillions of dollars) A Shift of the AE Line That Shifts the AD Curve C+I’+G+(X-M) (a) Investment increase shifts up e’ C+I+G+(X-M) 0.1 e 45° Price level 0 110 14.0 e 14.5 Real GDP (trillions of dollars) e’ AD 0 14.0 14.5 AD’ the aggregate expenditure line A shift of the aggregate expenditure line at a given price level shifts the aggregate demand curve. In panel (a), an increase in investment of $0.1 trillion, with the price level constant at 110, causes the aggregate expenditure line to increase from C+I+G+(X-M) to C+I‘+G+(X-M). As a result, real GDP demanded increases from $14.0 trillion to $14.5 trillion. (b) Investment increase shifts aggregate demand rightward In panel (b), the aggregate demand curve has shifted from AD out to AD’. At the prevailing price level of 110, real GDP demanded has increased by $0.5 trillion. Real GDP (trillions of dollars) © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 37
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Explanation & Answer

Attached.

Surname 1
Name
Institution
Tutor
Date
Economics Questions
Chapter 9:
1. Explain what a consumption function illustrates and interpret its slope
The consumption function illustrates the relationship that is between disposable income and
consumption. This is shown while other things remain constant.

Consumption Function
Real Consumption (billions of dollars)

300
250
200
150
100
50
0
-60

-40

-20

0

20

40

60

80

100

120

Real disposable income (billions of dollars)

The propensity of the consumption function shows a positive slope. The slope of the
consumption line is less than one and reflects induced consumption expenditures. This
implies that once the income increases, the level of consumption also increases.

Surname 2

S=DI- C
Consumption
Real Disposable Income

Expenditures

Saving

(Billions)

(Billions)

(Billions)

$100

$150

-50

$200

$200

0

$300

$250

50

$400

$300

100

4. How an increase in the following would affect consumption function.
a. Net taxes
When net taxes increase, the household disposable income will reduce which in turn means that
the availability of cash to spend on consumption is lessened. The same consumption function
therefore faces a downward movement.
b. The Interest rate
When the interest rate increases, the consumption lowers which in turn causes an increase in the
saving rates of the consumers.
c. Consumer optimism or confidence
An increase in consumer optimism may cause an increase in consumer spending. This positively
affects the consumer function since it is on an increase as well.
d. The price level

Surname 3
An increase in the price level will cause a downward shift to the consumption function. This is
because the prices of the goods become costly.
e. Consumer’s net wealth
The consumer’s net wealth when increased will increase the consumption function causing an
upward shift which is positive.
f. Disposable income
When disposable income is increased, the consumptio...


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