6.3 Changes in Equilibrium National Income

Question 1

What is the function for the simple multiplier?

Answer 1

Question 2

How do changes in household wealth change the equilibrium level of national income?

Answer 2

Changes in household wealth, such as those created by large and persistent swings in stock-market values, lead to changes in households’ desired consumption expenditure, thus changing the equilibrium level of national income.

Question 3

What are the two types of shifts in the AE that can occur?

Answer 3

Two types of shifts in AE can occur. First, if the same increase in expenditure occurs at all levels of income, the AE function shifts parallel to itself.

Second, if there is an increase in the marginal propensity to spend, the AE function becomes steeper.

Question 4

How do upward and downward shifts effect equilibrium?

Answer 4

Upward shifts in the AE function increase equilibrium income; downward shifts decrease equilibrium income.

Question 5

What happens to national income if there is a decrease in the amount of consumption or investment expenditure desired at each level of income?

Answer 5

These changes shift the AE function downward.

Question 6

What are the two types of downward shifts that can occure with the AE function?

Answer 6

An equal reduction in desired expenditure at all levels of income shifts AE parallel to itself. A fall in the marginal propensity to spend reduces the slope of the AE function.

Question 7

We have derived two important general propositions from our simple model of national income determination…

Answer 7

• A rise in the amount of desired aggregate expenditure at each level of national income will shift the AE curve upward and increase equilibrium national income.
• A fall in the amount of desired aggregate expenditure at each level of national income will shift the AE curve downward and reduce equilibrium national income.

Question 8

How do changes in the marginal propesity to spend effect the AE curve?

Answer 8

An increase in the marginal propensity to spend, z, steepens the AE curve and increases equilibrium national income. Conversely, a decrease in the marginal propensity to spend flattens the AE curve and decreases equilibrium national income.

Question 9

What is “The Multiplier”?

Answer 9

The multiplier is the change in equilibrium national income divided by the change in autonomous expenditure that brought it about.

In the simple macro model, the multiplier is greater than 1.

Question 10

What letter do we use to denote autonomous expenditure?

Answer 10

Let total autonomous expenditure be denoted by A

Question 11

Why is the multiplier more than 1?

Answer 11

The increase in national income of $500 million would cause an induced increase in desired consumption.

Electricians, masons, carpenters, and others—who gain new income directly from the building of the paper mills—will spend some of it on food, clothing, entertainment, cars, TVs, and other goods and services.

When output expands to meet this demand, new incomes will be created for workers and firms in the industries that produce these goods and services. When they, in turn, spend their newly earned incomes, output will rise further. More income will be created, and more expenditure will be induced.

Question 12

What happens to the AE function and its equilibrium when there is an increase in autonomous expenditure (delta)A

Answer 12

Remember that stands for any increase in autonomous expenditure; (Delta)A this could be an increase in investment or in the autonomous component of consumption. The AE function shifts upward by . National income is no longer in equilibrium because desired aggregate expenditure now exceeds actual national income. Equilibrium is restored by a movement along the new AE curve.

Question 13

Definition of the Simple multiplier.

Answer 13

Simple multiplier

      The ratio of the change in equilibrium national income to the change in autonomous expenditure that brought it about, calculated for a constant price level.

Question 14

Why do we refer to the simple multiplier as “simple”?

Answer 14

We refer to it as “simple” because we have simplified the situation by assuming that the price level is constant.

Question 15

What does an increase in autonomous aggregate expenditure do to equilibrium national income?

Answer 15

Question 16

Equlibrium occures when income rises to…

Answer 16

Question 17

What does the size of the simple multiplier depend on?

Answer 17

The size of the simple multiplier depends on the slope of the AE function—that is, on the marginal propensity to spend, z.

Question 18

What does a high marginal propensity to spend mean for the AE curve.

Answer 18

A high marginal propensity to spend means a steep AE curve.

The expenditure induced by any increase in income is large, with the result that the overall increase in Y caused by the upward shift of the AE curve is also large.

Question 19

What does a low marginal propensity to spend mean for the AE curve?

Answer 19

a low marginal propensity to spend means a relatively flat AE curve. The expenditure induced by any increase in income is small, and the overall rise in Y is not much larger than the shift in the AE curve that brought it about.

Question 20

The larger the marginal propensity to spend out of the nationl income…

Answer 20

The larger the marginal propensity to spend out of national income (z), the steeper is the AE curve and the larger is the simple multiplier.

Question 21

How does a marginal propensity to spend of 0 affect a change in equilibrium income?

Answer 21

The AE function is horizontal, indicating a marginal propensity to spend of zero . The change in equilibrium income is only the increase in autonomous expenditure because there is no induced expenditure by the people who receive the initial increase in income. The simple multiplier is then equal to 1, its minimum possible value.

Question 22

What letter do we use to denote the marginal propensity to spend?

Answer 22

z

Question 23

How does a low marginal propensity to spend affect the equlibrium national income when there is a shift?

Answer 23

the AE curve slopes upward but is still relatively flat (z is low). The increase in equilibrium national income to is only slightly greater than the increase in autonomous expenditure that brought it about. The simple multiplier is slightly greater than 1.

Question 24

How does a high marginal propensity to spend affect the equlibrium income when there is a shift?

Answer 24

the AE function is quite steep (z is high). Now the increase in equilibrium income to is much larger than the increase in autonomous expenditure that brought it about. The simple multiplier is much larger than 1.

Question 25

The larger the marginal propensity to spend…

Answer 25

The larger the marginal propensity to spend, the steeper the AE function and thus the larger the simple multiplier.

Question 26

What is the phenomina that economists call a “self-fulfilling prophecy”?

Answer 26

This link between expectations and national income suggests that expectations of a healthy economy can actually produce a healthy economy—what economists call a self-fulfilling prophecy.

Question 27

Answer 27

Question 28

If we have the simple multiplier, how can we use it to determine the MPS

Answer 28

Question 29

What can increase the simple multiplier?

Answer 29