7.4 Changes in Equilibrium National Income

Question 1

What kind of changes will cause a change in the equilibrium national income (GDP) ?

Answer 1

Changes in any of the components of desired aggregate expenditure will cause changes in equilibrium national income (GDP).

Question 2

What is the equation for the simple modifier?

Answer 2

In Chapter 6, we saw that the simple multiplier, the amount by which equilibrium real GDP changes when autonomous expenditure changes by $1, was equal to

1/(1 - z)

where z is the marginal propensity to spend out of national income.

Question 3

How does the presence of imports and taxes affect the marginal propensity to spend and the simple multiplier?

Answer 3

The presence of imports and taxes reduces the marginal propensity to spend out of national income and therefore reduces the value of the simple multiplier.

Question 4

What did the simple modifier look like without Goverment spending or taxes?

Answer 4

Question 5

What must we take into account when calculating the simple modifier with the presence of government and foreign trade?

Answer 5

In our expanded model with government and foreign trade, the marginal propensity to spend out of national income must take account of the presence of net taxes and imports, both of which reduce the value of z.

Question 6

What does the simple modifier function look like with Government and Trade?

Answer 6

Question 7

What happens to the simple multiplier when we introduce government and fireign trade?

Answer 7

When we introduce government and foreign trade to our macro model, the simple multiplier becomes smaller.

Since some of any increase in national income goes to taxes and imports, the induced increase in desired expenditure on domestically produced goods is reduced. (The AE curve is flatter.)

The result is that, in response to any change in autonomous expenditure, the overall change in equilibrium GDP is smaller.

Question 8

What is the effect of higher MPI and higher net tax rate on the simple modifier?

Answer 8

The higher is the marginal propensity to import, the lower is the simple multiplier. The higher is the net tax rate, the lower is the simple multiplier.

Question 9

How will changes in desired exports/imports shift the AE function and the equilibrium national income?

Answer 9

As with the other elements of aggregate expenditure, changes in desired exports and desired imports will shift the AE function and, through the multiplier process, cause a change in equilibrium national income.

Question 10

What would happen if foreign consumers desired to consume 1 billion more per year of goods then the had in the past?

Answer 10

Suppose foreign consumers develop a preference for Canadian-made furniture and desire to consume $1 billion more per year of these goods than they had in the past. The result will be a $1 billion increase in X, an upward shift of the AE function by $1 billion, and equilibrium national income will increase by $1 billion times the simple multiplier.

Question 11

What does Canadian imports of fireign products depend on?

Answer 11

Canadian imports of foreign products depend on Canadian income, international relative prices (including the exchange rate), and on Canadian firms’ and households’ preferences for foreign products.

For example, if Canadian firms decide to adjust their supply chains by purchasing more imported intermediate goods, Canada’s marginal propensity to import (m) will rise. The result will be a flattening of the AE curve and a reduction in Canada’s equilibrium national income.

Question 12

What is it called when government tries to stabilze the level of Real GDP closer to Potential GDP?

Answer 12

Question 13

Definition of Stabilization Policy.

Answer 13

Stabilization policy

      Any policy designed to reduce the cyclical fluctuations of Y around Y*.

Question 14

What are the two fiscal policy tools avaliable to government policymakers?

Answer 14

In our macro model, there are two fiscal policy tools available to government policymakers—the net tax rate (t) and government purchases (G).

Question 15

What does a reduction in the next tax rate or an increase in government purchases do to the AE curve?

Answer 15

A reduction in the net tax rate or an increase in government purchases shifts the AE curve upward, setting in motion the multiplier process that increases equilibrium national income

Question 16

What does an increase in the net tax rate or a decrease in government purchases to do the AE curve?

Answer 16

An increase in the net tax rate or a decrease in government purchases shifts the AE curve downward and decreases equilibrium income.

Question 17

What is difficult to determine when the government wats to change national income?

Answer 17

Once we know the direction in which the government wants to change national income, the directions of the required changes in government purchases or taxation are easy to determine. But the timing and magnitude of the changes are more difficult issues.

Question 18

Why are the issues of timing and magnitutde difficult to account for?

Answer 18

The issue of timing is difficult because it takes an uncertain amount of time before fiscal policies have an effect on real GDP. The issue of magnitude is difficult because the level of potential output can only be estimated imperfectly, and so the gap between actual and potential GDP is uncertain.

Question 19

Suppose the government decides to reduce its purchases of all consulting services, thus eliminating $200 million per year in spending. Planned government purchases (G) would fall by $200 million, shifting AE downward by the same amount.

How much would equilibrium income change?

Answer 19

This amount can be calculated by using the simple multiplier.

Government purchases are part of autonomous expenditure, so a change in government purchases of (Delta)G will lead to a change in equilibrium national income equal to the simple multiplier times.

Increases in government purchases would have the opposite effect. If the government increases its spending by $1 billion on the repair of highways, equilibrium national income will rise by $1 billion times the simple multiplier.

Question 20

How do changes in fiscal policy lead to changes in the equilibrium national income?

Answer 20

Question 21

How will changes in the net tax rate change the AE function?

Answer 21

Question 22

What happens with the AE curve if the government decreases its net tax rate by 5 cents for every dollar?

Answer 22

If the government decreases its net tax rate so that it collects 5 cents less out of every dollar of national income, disposable income rises in relation to national income. Hence, desired consumption also rises at every level of national income. This increase in consumption results in an upward rotation of the AE curve—that is, an increase in the slope of the curve

Question 23

What happens if the government increases net tax rate by 5 cents for every dollar?

Answer 23

A rise in the net tax rate has the opposite effect. A rise in the net tax rate causes a decrease in disposable income, and hence desired consumption expenditure, at each level of national income. This results in a downward rotation of the AE curve, which decreases the level of equilibrium national income.

Question 24

What is an important discinction about anything that makes the AE function rotate?

Answer 24

Note that when the AE function rotates, as happens if anything causes z to change, the simple multiplier is not used to tell us about the resulting change in equilibrium national income. The simple multiplier is only used to tell us how much equilibrium national income changes in response to a change in autonomous desired spending—that is, in response to a parallel shift in the AE function.

Question 25

What is the difference between writing consumption as a function of Disposable income and as a function of National income?

Answer 25

(Disposable income) - C = a + MPC(Y)

(National income) - C = a + MPC(1-t)Y

Question 26

How do we calculate the change in equilibrium national income when there is a change in MPS

Answer 26

After you find the change, make sure to find the difference between the new level and the old level.