ECN 204 Final Exam

What are the macroeconomic outcomes?

• Steady growth

• Full employment

• Stable prices

What is fiscal policy?

The changes in government purchases, taxes, and transfers to achieve macroeconomic outcomes of steady growth, full employment, and stable prices.

What are Injections when talking about fiscal policy?

Injections are spending within the circular flow that is not related to consumers (consumption)

• It includes spending that positively influence the economy

1.) Government spending (G)

2.) Business investing (I)

3.) Exports (X)

What do Injections do?

• They add wealth into the economy

• They bring in money into the circular flow

What are leakages when talking about fiscal policy?

Leakages are spending that are taken out of the circular flow by:

1.) Taxes

2.) Savings

3.) Imports

What do leakages do?

They take money out of the circular flow

What is the Multiplier effect?

The spending injection that has a multiplied effect on aggregate demand

What is a multiplier increase in aggregate demand?

1.) increase in government spending (G)

2.) decrease in tax (T)

3.) increase on government transfers (TR)

What is an example of a multiplier increase in aggregate demand?

An increase in G by $1.00 => the increase in real GDP (Y) will be more than $1.00

What is a multiplier decrease in aggregate demand?

1.) decrease in government spending

2.) increase in taxes

3.) decrease in government transfers

What is an example of a multiplier decrease in aggregate demand?

A decrease in G by $1.00 => the decrease in real GDP (Y) will be more than $1.00

What is the point of the multiplier effect?

The point is that even if we have a positive or negative effect, there will always be a multiplier effect

• The change in AD will be bigger than the original spending

What happens for each round of spending during the multiplier effect?

The total of each round becomes the base for the next year

What is an example of a round during the multiplier effect?

• Round 1: spent $100 dollars (puts $100 into the economy)

• Round 2: the $100 gets spent again, (it will not be the pure 100 dollars because some of it might be saved by a business or by a person) but $50 of the $100 might be spent

• The total effect becomes $150 (base of next period)

What is the point of the Round of Spending for an injection (money coming into the economy)?

The point is that an increase of government spending, tax cuts, and an increase of government transfers: GETS MULTIPLIED WITH EACH ROUND OF SPENDING

What does the size of the multiplier effect depend on?

The size of the multiplier effect depends on leakages out of the circular flow

What happens to the multiplier effect when the percent of leakage goes up?

When the percent of leakage goes up, the multiplier effect goes down

• an inverse relationship

What happens to the multiplier effect when the percent of leakage goes down?

When the percent of leakage goes down, the multiplier effect goes up

• an inverse relationship

In relation to an increase, rightward shift of the aggregate demand, what happens to the injections?

The AD curve will shift to the right because of an increase of injections by the multiplied effect of the original spending:

1.) Government spending

2.) Business investing

3.) Exports

In relation to a decrease, leftward shift of the aggregate demand, what happens to the injections?

The AD curve will shift to the left because of a decrease of injections by the multiplied effect of the original spending:

1.) Government spending

2.) Business investing

3.) Exports

How can you calculate your change in real GDP?

Through multiplier equations

1.) Change in real GDP = change in original spending (G, I, X) x multiplier

2.) Change in real GDP = change in original spending x 1/ 1 - MPC

3.) Change in real GDP = change in original spending x 1/ 1 - MPS

How can you calculate your multiplier effect?

Multiplier = change in real GDP / change in original spending

How can you calculate your MPC?

You can solve (find the missing variable) for the MPC with these equations depending on the information that the question gives you

1.) Multiplier = 1 / 1 - MPC

2.) Change in real GDP = change in original spending x 1/ 1 - MPC

What does MPC stand for and what does it mean?

Marginal Propensity to consume

• It means that if your income goes up by $1.00, the amount you spend will be bigger than 0, but the amount you spend will also be less than the $1.00

If your income goes up by $1.00 and you consume 75 cents of it, what is your MPC?

The MPC would be 75 cents

What does MPS stand for and what does it mean?

Marginal Propensity to Save

• It means that if your income goes up by $1.00, the amount you save will be bigger than 0, but the amount you save will also be less than the $1.00

If your income goes up by $1.00 and you consume 75 cents of it, what is your MPS?

The MPS would be 25 cents

What is the multiplier effect if real GDP = $200.00 and change in G = $100.00

$2.00

Multiplier = change in real GDP / change in original spending (G)

= $200.00 / $100

What is the MPC of the previous question since the multiplier is $2.00

1 / 2

Solve for MPC

Multiplier = 1 / 1 - MPC

2 = 1 / 1 - MPC

Step 1: multiply both sides by 1 - MPC

2 (1 - MPC) = 1 / 1 - MPC (1 - MPC)

2 (1 - MPC) = 1

Step 2: carry the 2 into the bracket

2 (1 - MPC) = 1

2 - 2MPC = 1

Step 3: drag the 2 onto the other side of the bracket

-2MPC = 1 - 2

-2MPC = -1

Step 4: divide both sides by -2 to find the MPC

-2MPC / -2 = -1 / -2

MPC = 1 / 2

What is the real GDP if your change in G = $100 and your MPC = 0.25

$133.00

Change in real GDP = change in G x 1 / 1 - MPC

100 x 1 / 1 - 0.25