Economics (7th Edition) (What's New in Economics)
7th Edition
ISBN: 9780134738321
Author: R. Glenn Hubbard, Anthony Patrick O'Brien
Publisher: PEARSON
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Chapter 27.A, Problem 3PA
To determine
The aggregate demand curve.
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Why would a higher tax rate lower the government purchases multiplier? What does the tax rate have to do with the government purchases multiplier?
Graphically illustrate the effect of an increase in government purchases. Explain the government spending multiplier effect by using at least 200 words.
Suppose the following list of events describes all of the economic activity resulting from an increase in government spending.
Suppose that at each step after the initial one, the marginal propensity to consume is 0.67 and the tax rate is 16%.
Step 0. The government spends $8500 on meat to host a very large dinner for foreign diplomats.
Step A. The butcher takes the income earned by selling the meat, saves some, and spends the rest on a wedding cake for his
daughter.
Step B. The baker who produced the wedding cake saves some of her earnings and uses the rest to purchase beautiful
candlesticks as gifts for all of her friends.
Step C. The local candlestick maker saves some of his revenue for retirement and spends the rest on building materials to
improve his house.
Instructions: Modify the settings in the interactive tool to represent this event. Then click "Spending Rounds" and use the table to
answer the following questions. Round answers to the nearest cent, if necessary.
How much…
Chapter 27 Solutions
Economics (7th Edition) (What's New in Economics)
Ch. 27.A - Prob. 1PACh. 27.A - Prob. 3PACh. 27.A - Prob. 4PACh. 27.A - Prob. 5PACh. 27 - Prob. 27.1.1RQCh. 27 - Prob. 27.1.2RQCh. 27 - Prob. 27.1.3RQCh. 27 - Prob. 27.1.4PACh. 27 - Prob. 27.1.5PACh. 27 - Prob. 27.1.6PA
Ch. 27 - Prob. 27.1.7PACh. 27 - Prob. 27.2.1RQCh. 27 - Prob. 27.2.2RQCh. 27 - Prob. 27.2.3PACh. 27 - Prob. 27.2.4PACh. 27 - Prob. 27.2.5PACh. 27 - Prob. 27.2.6PACh. 27 - Prob. 27.2.7PACh. 27 - Prob. 27.2.8PACh. 27 - Prob. 27.3.1RQCh. 27 - Prob. 27.3.2RQCh. 27 - Prob. 27.3.3PACh. 27 - Prob. 27.3.4PACh. 27 - Prob. 27.3.5PACh. 27 - Prob. 27.3.6PACh. 27 - Prob. 27.4.1RQCh. 27 - Prob. 27.4.3RQCh. 27 - Prob. 27.4.4PACh. 27 - Prob. 27.4.5PACh. 27 - Prob. 27.4.6PACh. 27 - Prob. 27.4.7PACh. 27 - Prob. 27.4.8PACh. 27 - Prob. 27.4.9PACh. 27 - Prob. 27.5.1RQCh. 27 - Prob. 27.5.2RQCh. 27 - Prob. 27.5.3PACh. 27 - Prob. 27.5.4PACh. 27 - Prob. 27.5.5PACh. 27 - Prob. 27.5.6PACh. 27 - Prob. 27.5.7PACh. 27 - Prob. 27.6.1RQCh. 27 - Prob. 27.6.2RQCh. 27 - Prob. 27.6.3RQCh. 27 - Prob. 27.6.4RQCh. 27 - Prob. 27.6.5PACh. 27 - Prob. 27.6.6PACh. 27 - Prob. 27.6.7PACh. 27 - Prob. 27.6.9PACh. 27 - Prob. 27.6.10PACh. 27 - Prob. 27.6.11PACh. 27 - Prob. 27.7.1RQCh. 27 - Prob. 27.7.2RQCh. 27 - Prob. 27.7.3RQCh. 27 - Prob. 27.7.4PACh. 27 - Prob. 27.7.5PACh. 27 - Prob. 27.7.7PACh. 27 - Prob. 27.7.8PACh. 27 - Prob. 27.1CTE
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- Suppose the following list of events describes all of the economic activity resulting from an increase in government spending. Suppose that at each step after the initial one, the marginal propensity to consume is 0.62 and the tax rate is 8%. Step 0. The government spends $8500 on meat to host a very large dinner for foreign diplomats. Step A. The butcher takes the income earned by selling the meat, saves some, and spends the rest on a wedding cake for his daughter. Step B. The baker who produced the wedding cake saves some of her earnings and uses the rest to purchase beautiful candlesticks as gifts for all of her friends. Step C. The local candlestick maker saves some of his revenue for retirement and spends the rest on building materials to improve his house. Instructions: Modify the settings in the interactive tool to represent this event. Then click "Spending Rounds" and use the table to answer the following questions. Round answers to the nearest cent, if necessary. How much does…arrow_forwardSuppose there is some hypothetical closed economy in which households spend $0.80 of each additional doilar they earn and save the remaining $0.20. The marginal propensity to consume (MPC) for this economy is , and the spending multiplier for this economy is Suppose the government in this economy decides to decrease government purchases by $400 billion. The decrease in government spending will lead to a decrease in income, creating an initial change in consumption equal to This decreases income yet again, leading to a second change in consumption equal to The total change in demand resulting from the initial change in government spending isarrow_forwardGovernment expenditures represents one of the injections of expenditure. Explain how an increase in government spending may have a multiplier effect in the economy.arrow_forward
- Consider a hypothetical economy. Households spend $0.50 of each additional dollar they earn and save the remaining $0.50. The multiplier for this economy is . Suppose government purchases, G, in this economy increase by $300 billion. The increase in G will lead to an increase in income, generating an increase in consumption that increases income yet again, and so on. Fill in the following table to show the impact of the change in G on the first two rounds of consumption spending and, eventually, on national income. Note: Use negative signs if numbers are negative. Change in G = $300 billion First Change in Consumption = billion Second Change in Consumption = billion • • • • • • Total Change in Income = billion Now consider the impact of a similar change in taxes. The (absolute value) of the tax multiplier in this question will be ; thus, if taxes change by $300 billion, spending will change by billion. Based on…arrow_forwardConsider a hypothetical economy. Households spend $0.90 of each additional dollar they earn and save the remaining $0.10. The multiplier for this economy is . Suppose government purchases, G, in this economy decrease by $150 billion. The decrease in G will lead to a decrease in income, generating a decrease in consumption that decreases income yet again, and so on. Fill in the following table to show the impact of the change in G on the first two rounds of consumption spending and, eventually, on national income. Note: Use negative signs if numbers are negative. Change in G = −$150 billion First Change in Consumption = billion Second Change in Consumption = billion • • • • • • Total Change in Income = billion Now consider the impact of a similar change in taxes. The (absolute value) of the tax multiplier in this question will be ; thus, if taxes change by -$150 billion, spending will change by billion. Based on…arrow_forwardHow does an increase in tax influence the size of the multiplierarrow_forward
- The economy of Bananaland can be characterized by Equation 9.3. EQUATION 9.3: C = 2,000 + 0.75Yd T = 200 G = 400 I = 500 Calculate the government spending multiplier.arrow_forwardSuppose there is some hypothetical economy in which households spend $0.50 of each additional dollar they earn and save the $0.50 they have left over. The following graph plots the economy's initial aggregate demand curve (ADI). Suppose now that the government increases its purchases by $3.5 billion. Use the green line (triangle symbol) on the following graph to show the aggregate demand curve (AD) after the multiplier effect takes place. Hint: Be sure the new aggregate demand curve (AD) is parallel to AD₁. You can see the slope of AD, by selecting it on the following graph. PRICE LEVEL 116 114 112 110 108 106 104 102 AD 100 100 102 104 106 108 110 OUTPUT (Billions of dollars) 112 114 116 AD₂ | | AD₂ The following graph plots equilibrium in the money market at an interest rate of 3% and a quantity of money equal to $30 billion. Show the impact of the increase in government purchases on the interest rate by shifting one or both of the curves on the following graph. Money Supply Money…arrow_forwardThe multiplier effect of a change in government purchases Suppose there is some hypothetical closed economy in which households spend $0.80 of each additional dollar they earn and save the remaining $0.20. The marginal propensity to consume (MPC) for this economy is (0.2 or 0.8 or 1 or 1.25 or 5), and the spending multiplier for this economy is (0.2 or 0.8 or 1 or 1.25 or 5). Suppose the government in this economy decides to increase government purchases by $400 billion. The increase in government spending will lead to an increase in income, creating an initial change in consumption equal to (320 billion or 2000 billion or 1000 billion or 80 billion or 160 billion). This increases income yet again, leading to a second change in consumption equal to (160 billion or 80 billion or 1000 billion or 2000 billion or 256 billion). The total change in demand resulting from the initial change in government spending is (2 trillion or 0.8 trillion or 1.6 trillion or 3.2 trillion).arrow_forward
- The multiplier effect of a change in government purchases Suppose there is some hypothetical closed economy in which households spend $0.75 of each additional dollar they earn and save the remaining $0.25. The marginal propensity to consume (MPC) for this economy is (0.25 or 0.75 or 1 or 1.33 or 4), and the spending multiplier for this economy is (0.25 or 0.75 or 1 or 1.33 or 4). Suppose the government in this economy decides to decrease government purchases by $250 billion. The decrease in government spending will lead to a decrease in income, creating an initial change in consumption equal to (-$1,000 billion or -$187.5 billion or -$93.8 billion or - $62.5 billion or -500 billion). This decreases income yet again, leading to a second change in consumption equal to (- $93.8 billion or - 1,000 billion or - $500 billion or - $140.6 billion or -62.5 billion). The total change in demand resulting from the initial change in government spending is (-$1 trillion or - $1.9…arrow_forwardSuppose the following data for an economy; a consumption function of C = 800 + 0.8Yd, Investment spending is fixed at 300, Government purchases are 400, and net taxes are 100. What is the MPC, MPS, and the value of the tax multiplier? Calculate the equilibrium level of income (Y)? Suppose government increases taxes by 100, use the corresponding multiplier to calculate the new equilibrium level of income. Check to ensure that the multiplier worked (confirm algebraically that your answer in c. is correct, that is, solve for the new equilibrium level of income (Y)).arrow_forwardSuppose government purchases increase by 10 billion dollars, and as a result, real GDP increases by 15 billion dollars. Calculate the multiplier. Explain why the multiplier is generally greater than 1.arrow_forward
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