Chapter 18, Problem 5C

Subpart (a):

To determine

To determine: The range of real GDP.

Explanation of Solution

The range of real GDP is a set comprising of a low estimate and a high estimate. The range of real GDP is estimated using the following equation.

$\text{Range of Real GDP = }\left[{\text{Low estimate}}_{\text{GDP}},{\text{High estimate}}_{\text{GDP}}\right]$ (1)

Here

$\begin{array}{l}{\text{Low estimate}}_{\text{GDP}}{\text{ = Low estimate}}_{\%\text{ change}}\times \text{Real GDP}\\ {\text{High estimate}}_{\text{GDP}}{\text{ = High estimate}}_{\%\text{ change}}\times \text{Real GDP}\end{array}$

Using equation (1), the range of real GDP for 2009 is calculated as follows:

$\begin{array}{c}{\text{Low estimate}}_{\text{GDP}}\text{ = }\frac{0.9}{100}\times \text{12}\text{.71}\times {\text{10}}^9\\ \text{=114}\text{.4}\times {\text{10}}^6\\ =114.4\text{ billion}\\ {\text{High estimate}}_{\text{GDP}}\text{ = }\frac{1.9}{100}\times \text{12}\text{.71}\times {\text{10}}^9\\ \text{= 241}\text{.5}\times {\text{10}}^6\\ =241.5\text{ billion}\end{array}$

Hence, the range of real GDP for 2009 is $\left[\$114.4\text{ billion },\text{ \$ }241.5\text{ billion}\right]$.

Similarly using equation (1), the range of real GDP for all the given years is estimated and tabulated in table 1.

Table 1

CBO Estimates Aug. 2011	Change Attributable to the ARRA
	Increased Real GDP (billions of 2005 $)
	Low estimate	High estimate
2009	114.4	241.5
2010	196.4	549.8
2011 (1st & 2nd Qtr)	62.9	188.8
Total $\left(=2009+2010+2011\left({\text{1}}^{\text{st}}{\text{\& 2}}^{\text{nd}}\text{Qtr}\right)\right)$	373.6	980.6

Economics Concept Introduction

Concept Introduction:

Real GDP: Real Gross Domestic Product is the total market value of all the final goods and services produced in a country in a given year.

Subpart (b):

To determine

The Midpoint growth estimates.

Explanation of Solution

The Midpoint growth percent is calculated using the following equation:

$\text{Midpoint growth \% = }\frac{{\text{Low estimate}}_{\text{\% change}}{\text{+ High estimate}}_{\text{\% change}}}{2}$ (2)

Using equation (2), Midpoint growth per cent for 2009 is calculated as follows:

$\begin{array}{c}\text{Midpoint growth \% = }\frac{\text{0}\text{.9+ 1}\text{.9}}{2}\\ =\frac{2.8}{2}\\ =1.4\end{array}$

The midpoint growth percent for 2009 is 1.4%.

The Midpoint growth estimate is calculated using the following equation:

$\text{Midpoint growth = Midpoint growth \% }\times \text{Real GDP}$ (3)

Using equation (3), Midpoint growth estimate for 2009 is calculated as follows:

$\begin{array}{c}{\text{Midpoint growth}}_{\text{Real GDP}}\text{ = }\frac{1.4}{100}\times 12.71\times {10}^9\\ =\text{177}\text{.9}\times {\text{10}}^6\\ =177.9\text{ billion}\end{array}$

The midpoint growth for 2009 is $ 177.9 billion.

Similarly using equation (2) and (3), the midpoint results for all the given years is estimated and tabulated in table 2.

Table 2

CBO Estimates Aug. 2011	Midpoint Results
	Midpoint Growth Estimate (Per cent)	Increased Real GDP (billions of 2005 $)
2009	1.4	177.9
2010	2.85	373.1
2011 (1st & 2nd Qtr)	1.9	125.9
Total $\left(=2009+2010+2011\left({\text{1}}^{\text{st}}{\text{\& 2}}^{\text{nd}}\text{Qtr}\right)\right)$		676.9

Economics Concept Introduction

Concept Introduction:

Real GDP: Real Gross Domestic Product is the total market value of all the final goods and services produced in a country in a given year.

Subpart (c):

To determine

The multiplier effect.

Explanation of Solution

The multiplier effect is evaluated by comparing the estimates with the actual values.

1. 1. The low estimate is $ 373.6 billion and the actual stimulus spending is 677.6. The difference between the estimate and the actual value is -$303.9 $\left(373.6-677.6\right)$ billion. Since the value is negative, the multiplier is less than1, thus it is the generated crowding out effect.

1. 2. The midpoint estimate is $ 676.9 billion and the actual stimulus spending is 677.6. The difference between the estimate and the actual value is approximately 0 $\left(676.9-677.6\right)$. Since the value is closer to 0, multiplier is equal to 1, hence there is no multiplier effect.

1. 3.  The high estimate is $ 980.6 billion and the actual stimulus spending is 677.6. The difference between the estimate and the actual value is approximately $302.5 $\left(980.6-677.6\right)$ billion. Since the value is positive, the multiplier is greater than 1, hence there is multiplier effect.

Economics Concept Introduction

Concept Introduction:

Multiplier: Multiplier refers to the ratio of change in the real GDP to the change in the initial consumption at a constant price rate. Multiplier is positively related to the marginal propensity of the consumer and negatively related to the marginal propensity to save.

Subpart (d):

To determine

The range of a multiplier effect.

Explanation of Solution

The low estimate suggests a crowding out and the midpoint estimates suggest no multiplier effect. However, the high estimate suggests a multiplier effect in the range of that which is forecasted by the White House during that time and the implied would be 0.55, 0.99, and 1.45, respectively.

Economics Concept Introduction

Concept Introduction:

Multiplier: Multiplier refers to the ratio of change in the real GDP to the change in the initial consumption at a constant price rate. Multiplier is positively related to the marginal propensity of the consumer and negatively related to the marginal propensity to save.

Crowding out: Crowding out effect refers to the decrease in the availability of money for the private investment due to the increase in the fiscal expansion.

Subpart (e):

To determine

The limits of fiscal policy that is explaining the variation in the size of an impact estimate.

Explanation of Solution

Crowding out, a drop in the bucket and a matter of timing are possible limits of fiscal policy and they explain why the size of the impact estimated varied from the 1.57 multiplier effect forecasted by the White House at the time of the ARRA legislation

1. 1. Crowding out may have occurred in the categories of reduced consumption spending and reduced spending on alternative assets, since the Fed kept interest rates are low as the taxes were not increased but bonds were sold.
2. 2. There was only a drop in the bucket, since the stimulus was small in real terms as it accounts only 5 percent of average real GDP.
3. 3. Fiscal policy lags were clearly visible throughout the stimulus process.

Economics Concept Introduction

Concept Introduction:

Multiplier: Multiplier refers to the ratio of change in the real GDP to the change in the initial consumption at a constant price rate. Multiplier is positively related to the marginal propensity of the consumer and negatively related to the marginal propensity to save.

Crowding out: Crowding out effect refers to the decrease in the availability of money for the private investment due to increase in the fiscal expansion.

Subpart (f):

To determine

The fiscal policy during the Aggregate demand shock.

Explanation of Solution

The authors stress on the point that the Fiscal policy is the strongest when the economy is in an Aggregate demand shock that is a recession caused by a low aggregate demand. The low aggregate demand is caused by the decrease in the demand in housing sectors and its reverberations, the decrease in consumer confidence and the firms’ unwillingness to invest has given increased levels of uncertainty. Low aggregate demand also subsequently slows down the money growth and the financial intermediation.

Economics Concept Introduction

Concept Introduction:

Fiscal Policy: It deals with the taxation and the expenditure decisions of the government that influence a nation’s economy.

Aggregate demand (AD): Aggregate demand refers to the total value of the goods and services that are demanded at a particular price in a given period of time.