Chapter 22 Adding Government And Trade To The Simple Macro Model
1. Introducing Government
Net Tax Revenues
How does “T” enter our model?
The Budget Balance
2. Introducing Foreign Trade
Net export function
Example: The Net Export Function
Actual National Desired
Draw export, import, and net export functions
Shifts in the Net Export Function
1. Changes in Foreign Income
2. Changes in International Relative Prices
3. Equilibrium National Income
Adding Taxes to the Consumption Function
1. First, assume that the net tax rate, t, is 10%, so that net tax revenues are 10%
of national income (GDP):
2. Disposable income must therefore be 90% of national income:
3. The consumption function we used last chapter is given as C = 30 + 0.8YD
4. Now substitute 0.9Y for YD in the consumption function. We get:
The AE Function
Example: The Aggregate Expenditure Function
Draw the graph.
Equilibrium National Income
4. Changes in Equilibrium National Income
The Multiplier with Taxes and Imports
Without Government and trade
With Government and trade
What happens to the simple multiplier if t is larger? If m is larger?
Fiscal Policy: Government Spending and Taxation
1) Changes in Government Purchases
2) Changes in Tax Rates
Chapter 23 Real GDP and the Price Level in the Short Run
• Demand side: Aggregate demand and its shifts
• Supply side: Aggregate supply and its shift
• Macroeconomic Equilibrium: put AD and AS together
1. The Demand Side of the Economy
Exogenous Changes in the Price Level
Changes in Consumption
Changes in Net Exports
Change in Equilibrium GDP
A Change of Labels
Derive the Aggregate Demand Curve
Shifts in the AD Curve
2. The Supply Side of the Economy
The Aggregate Supply Curve
The Positive Slope of the AS Curve
The Increasing Slope of the AS Curve
Shifts in the AS Curve
Changes in Input Prices
Changes in Technology
3. Macroeconomic Equilibrium
Changes in the Macroeconomic Equilibrium
Aggregate Demand Shocks
The Multiplier When the Price Level Varies
The Importance of the Shape of the AS Curve
Consider a positive AD shock.
Over the flat range (Also called Keynesian range):
Over the intermediate range:
Over the steep range:
Aggregate Supply Shocks
A Word of Warning
Chapter 24 From the Short Run to the Long Run: The Adjustment of Factor
Three Macroeconomic States
The Adjustment Process
AD and AS Shocks
Fiscal Stabilization Policy
1. Three Macroeconomics States
The Short Run
The Adjustment of Factor Prices
The Long Run
2. The Adjustment Process
Factor Prices and the Output Gap
1) Inflationary Gap
2) Recessionary Gap
Downward Wage Stickiness
The Phillips Curve
3. Aggregate Demand and Supply Shocks
Positive AD shocks
Negative AD shocks
What if wages are “sticky”?
Aggregate Supply Shocks
In conclusion, following any AD or AS shocks:
What does Y* depend on?
Long-run aggregate supply curve
A change in AD in long-run equilibrium
A change in Y*
4. Fiscal Stabilization Policy
1) Closing a Recessionary Gap
2) Closing an Inflationary Gap
3) the Paradox of Thrift
Automatic Fiscal Stabilizers
Limitations of Discretionary Fiscal Policy
Past Exam Questions
Prof. Jinyue Li
MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
1) Consider the government’s budget balance. Suppose G = 2500 and the government’s net tax
revenue is equal to 0.2Y. When Y = 11 000, the government is running a budget
A) deficit of 300.
B) surplus of 1500.
C) surplus of 300.
D) deficit of 1500.
2) Which of the following can cause a parallel downward shift in the net export (NX) function?
A) a decrease in foreign prices
B) an increase in the Canadian-dollar price of foreign currency
C) a decrease in foreign national income
D) a decrease in domestic prices
E) an increase in domestic national income
3) Consider the general form of the consumption function in a simple macro model. Once
government and taxes are included in the model, desired consumption can be expressed as
________, where a = autonomous consumption, t = net tax rate, Y = national income, YD =
disposable income, and MPC = marginal propensity to consume.
A) C = a + MPC · Y
B) C = a – (1 – t)YD
C) C = a + MPC · t · YD
D) C = a + MPC(1 – t)Y
E) C = a + MPC(1 – t)YD
4) Consider a simple macro model with a constant price level and demand-determined output. The
equations of the model are: C = 120 + 0.86Y, I = 300, G = 520, T = 0, X = 180, IM = 0.12Y. Total
autonomous spending in this model is
5) Consider a simple macro model with a constant price level and demand-determined output. The
equations of the model are: C = 120 + 0.86Y, I = 300, G = 520, T = 0, X = 180, IM = 0.12Y. If national
income is 2400, then desired aggregate expenditure is
6) An increase in the value of the simple multiplier can be caused by
A) an increase in the marginal propensity to import.
B) a decrease in the marginal propensity to consume.
C) an increase in the marginal propensity to save.
D) a decrease in the net tax rate.
E) an increase in the net tax rate.
7) The diagram below shows desired aggregate expenditure for a hypothetical economy. Assume the following
features of this economy:
• marginal propensity to consume (mpc) = 0.80
• net tax rate (t) = 0.15
• no foreign trade
• fixed price level
• all expenditure and income figures are in billions of dollars.
Refer to Figure 22-3. Which of the following equations describes the aggregate expenditure
function for this economy?
A) AE = 1975 + (0.68)Y
B) AE = 1975 + (0.65)Y
C) AE = 1000 + (0.80)YD
D) AE = 1000 + (0.80)Y + 0.15 YD
E) AE = 1000 + (0.68)Y
8) In a simple macro model, it is generally assumed that a country’s exports
A) and imports are autonomous.
B) are always equal to investment.
C) are induced, whereas imports are autonomous.
D) are autonomous, whereas imports are induced.
E) and imports are induced.
Refer to Figure 22-4. The rotation from AE0 to AE1 could be caused by
A) a higher net tax rate.
B) lower government purchases.
C) a balanced budget.
D) a lower net tax rate.
E) higher government purchases.
10) A rise in domestic prices relative to foreign prices, other things being equal, causes the net export
(NX) function to shift ________ and ________.
A) upward; become flatter
B) upward; become steeper
C) downward; become flatter
D) downward; keep the same slope
E) downward; become steeper
11) Consider the simple multiplier when the price level is constant. We can say that national income is
________ and that the simple multiplier measures the horizontal shift in ________ in response to a
change in autonomous desired expenditure.
A) demand determined; the AS curve
B) demand determined; the AD curve
C) constant; the AD curve
D) unit-cost determined; the AD curve
E) constant; the AE curve
12) The aggregate supply curve will shift as a result of a change in
1) the wage rate;
2) the price level;
A) 1 only
B) 2 only
C) 3 only
D) 1 and 3
E) 2 and 3
13) An aggregate demand shock will have a large effect on real GDP and a small effect on the price
A) the AS curve is steep.
B) the AS curve is vertical.
C) the AS curve is close to horizontal.
D) the AD curve intersects the AS curve on the downward-sloping portion of the AS curve.
E) the AD curve is steep.
14) Consider the following news headline: “Governments plan massive hospital construction
programs across the country.” Choose the statement below that best describes the likely
A) The AD curve shifts to the left; the price level falls and real GDP falls.
B) The AD curve shifts to the right; the price level rises and real GDP rises.
C) The AD and AS curves both shift to the right; the effect on the price level is indeterminate
and real GDP rises.
D) The AD curve shifts to the right and the AS curve shifts to the left; the price level rises and
the effect on real GDP is indeterminate.
E) The AD curve shifts to the left and the AS curve shifts to the right; the price level falls and the
effect on real GDP is indeterminate.
15) Consider the following two headlines appearing in the same day: “Federal government announces
major new infrastructure investments” and “New technology drives down transport costs.” Choose
the statement below that best describes the likely macroeconomic effects.
A) The AD curve shifts to the right; the price level rises and real GDP rises.
B) The AD and AS curves both shift to the right; the effect on the price level is indeterminate
and real GDP rises.
C) The AS curve shifts to the right; the price level falls and real GDP rises.
D) The AD curve shifts to the left; the price level falls and real GDP falls.
E) The AS curve shifts to the left; the price level rises and real GDP falls.
16) Consider a simple macro-model with demand-determined output. An exogenous increase in the
domestic price level will ________ the real value of the private sector’s wealth, which leads to
________ in autonomous consumption and thus ________ shift in the AE function.
A) increase; a decrease; a downward
B) reduce; an increase; an upward
C) increase; an increase; a downward
D) reduce; a decrease; a downward
E) increase; an increase; an upward
Refer to Figure 23-4. Suppose the Canadian economy is initially in equilibrium at point A. An
unexpected shock then shifts both the AD and the AS curves as shown and results in a new
equilibrium represented by point B. Which of the following events could cause such a shock?
A) a decrease in firms’ desired investment expenditures
B) an increase in factor prices
C) a decrease in labour productivity
D) an increase in the net tax rate
E) a decrease in the world price of oil
18) Consider a simple macro model with a given price level and demand-determined output. An
exogenous change in the price level causes a
A) movement along both the AE and AD curves.
B) movement along the AE curve and a shift in the AD curve.
C) shift in both the AE and AD curves.
D) movement along AE but does not affect the AD curve.
E) shift in the AE curve and a movement along the AD curve.
19) Which of the following would cause a positive aggregate demand shock, but leave the aggregate
supply curve unaffected?
A) A substantial increase in world oil prices.
B) An improvement in the computer literacy of workers.
C) A medical report confirming that improved health for Canadian workers caused fewer lost
days of production.
D) A free trade agreement between Canada and Europe that leads Canadian businesses to
increase investment expenditures.
E) A severe drought lasting for six months that destroys agricultural and forestry production.
20) Which of the following would likely cause an upward parallel shift in the AE curve and a
rightward shift in the AD curve?
A) an increase in the price level
B) an increase in the MPC
C) a reduction in government purchases
D) a decrease in the price level
E) an increase in the business confidence of firms
21) Which of the following are the defining assumptions of the long run in macroeconomics?
A) Factor prices have fully adjusted to output gaps, and technology and factor supplies are
B) Factor prices are exogenous, and technology and factor supplies are changing.
C) Factor prices are exogenous, and technology and factor prices are exogenous.
D) Factor prices adjust to output gaps, and technology and factor supplies are constant.
E) Factor prices are exogenous, and technology and factor supplies are constant.
22) In the basic AD/AS model, which of the following is a defining assumption of the adjustment
process that takes the economy from the short run to the long run?
A) Firms cannot operate near their normal capacity.
B) The level of potential output is changing.
C) Technology used in production is endogenous.
D) Factor supplies are assumed to be varying.
E) Factor prices respond to output gaps.
23) The Phillips curve describes the relationship between which two variables?
A) aggregate expenditure and aggregate demand
B) inflation and interest rates
C) the output gap and potential GDP
D) the money supply and interest rates
E) unemployment and the rate of change of wages
24) Consider the AD/AS model. Since output in the long run is determined by Y*, the only role of the
AD curve is to determine the price level. This is true because
A) the AS curve is upward sloping.
B) Y* is independent of the price level.
C) Y* depends on the price level.
D) the aggregate demand curve is horizontal.
E) the aggregate demand curve is vertical.
25) Why are income taxes in Canada considered to be automatic stabilizers? Because
A) tax revenues are changed through discretionary fiscal policy to create surpluses in recessions.
B) tax revenues are changed through discretionary fiscal policy to keep the budget balanced.
C) tax revenues decrease when income increases, thereby intensifying the increase in aggregate
D) tax structures can be changed when the Minister of Finance brings down a budget.
E) tax revenues increase when income increases, thereby offsetting some of the increase in
Refer to Figure 24-1. If the economy is currently in a short-run equilibrium at Y0 , the economy is
A) a labour shortage.
B) a long-run equilibrium.
C) potential output growth.
D) an inflationary output gap.
E) a recessionary output gap.
27) Refer to Figure 24-1. If the economy is currently producing output of Y0 , the economy’s automatic
adjustment process will have the
A) AD curve shifting to the right until point B is reached.
B) vertical line at Y* shifting to the left until it gets to Y0 .
28) Refer to Figure 24-1. If the economy is currently producing output of Y0 and wages are sticky
downwards, then the
A) economy will move only slowly toward point A as wages slowly adjust.
B) economy will eventually move to point B.
C) level of output will decrease below Y0 .
D) economy will quickly move to point A.
E) AD curve will eventually shift to the right and return the economy to its full-employment
level of output.
C) economy remaining where it is.
D) level of potential output falling.
E) AS curve shifting to the right until point A is reached.
29) Suppose the following conditions are present in the economy:
– firms are increasing output to meet rising demand for their goods
– workers are able to demand higher wages as firms try to bid workers away from other firms
Which of the following statements describes the adjustment that will happen in the AD/AS macro
A) There is an inflationary output gap; wages and other factor prices will rise; the AS curve will
shift to the left until equilibrium is restored at Y*.
B) The economy is in equilibrium at Y*, but wages are rising. The AS curve will shift to the left
until a new equilibrium is reached at a higher price level.
C) There is a recessionary output gap; wages and other factor prices will rise; the AS curve will
shift to the left until equilibrium is restored at Y*.
D) There is a recessionary output gap; aggregate demand will rise, causing the AD curve to shift
to the right until equilibrium is restored at Y *.
E) There is an inflationary output gap; aggregate demand will continue to increase, causing the
AD curve to shift to the right. The price level will rise until equilibrium is restored at Y*.
30) The diagram below shows an AD/AS model for a hypothetical economy which is initially in a short-run
equilibrium at point A.
Refer to Figure 24-6. In the initial short-run equilibrium, there is ________ output gap of ________,
but this gap could be closed by a ________.
A) a recessionary; 200; fiscal expansion
B) an inflationary; 200; fiscal expansion
C) a recessionary; 200; fiscal contraction
D) an inflationary; 100; fiscal contraction
E) a recessionary; 100; fiscal contraction
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