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ECON Macro Canadian 1st Edition McEachern Solutions Manual 1
ECON Macro Canadian 1st Edition McEachern Solutions Manual 1
ECON Macro Canadian 1st Edition McEachern Solutions Manual 1
CHAPTER 9
AGGREGATE EXPENDITURE AND AGGREGATE DEMAND
1.1 (Consumption) Use the following data to answer the questions below.
$100 $150 $
200 200
300 250
400 300
a. Graph the consumption function, with consumption spending on the vertical axis and disposable income
on the horizontal axis.
b. If the consumption function is a straight line, what is its slope?
c. Fill in the saving column at each level of income. If the saving function is a straight line, what is its slope?
a.
2.1 (Investment) Why would the following investment expenditures increase as the interest rate declines?
a. Purchases of a new plant and equipment
b. Construction of new housing
c. Increase of inventories
a. As interest rates fall, holding revenue from the use of the equipment constant, it becomes easier to
finance the purchase of new plants and equipment.
b. With lower interest rates, mortgage rates fall. This induces more individuals to consider building new
houses.
c. Lower interest rates mean that an expansion of less productive, less profitable inventories can be
financed more easily. This will cause firms to be more willing and able to expand inventories.
2.2 (Government Spending) How do changes in disposable income affect government purchases and the
government purchase function? How do changes in net taxes affect the consumption function?
Government purchases are assumed to be autonomous of disposable income. The government purchase
function is a horizontal line, and changes in income have no effect on government purchases.
Changes in net taxes affect the consumption function indirectly. An increase in net taxes reduces the level of
disposable income, causing movement downward along the consumption function.
3.1 (Aggregate Expenditure) What are the components of aggregate expenditure? Which components vary with
changes in the level of real GDP? What determines the slope of the aggregate expenditure line?
The components of aggregate expenditure are (a) consumption, (b) investment, (c) government purchases,
and (d) net exports. Only consumption varies with the level of real GDP; the other components are assumed
to be autonomous. Therefore, the slope of the aggregate expenditure function equals the MPC.
4.1 (Simple Spending Multiplier) For each of the following values for the MPC, determine the size of the simple
spending multiplier and the total change in real GDP demanded following a $10-billion decrease in spending:
a. MPC = 0.9
b. MPC = 0.75
c. MPC = 0.6
4.2 (Simple Spending Multiplier) Suppose that the MPC = 0.8 and that $2 trillion of real GDP is currently being
demanded. The government wants to increase real GDP demanded to $2.4 trillion at the given price level. By
how much would it have to increase government spending to achieve this goal?
The simple spending multiplier is 5. If government spending is increased by $80 billion, real GDP demanded
will increase by five times $80 billion, or $400 billion, bringing real GDP demanded to a total of $2.4 trillion.
5.1 (Shifts in Aggregate Demand) Assume the simple spending multiplier equals 10. Determine the size and
direction of any changes in the aggregate expenditure line, real GDP demanded, and the aggregate demand
curve for each of the following changes in spending:
a. Spending rises by $8 billion at each income level.
b. Spending falls by $5 billion at each income level.
c. Spending rises by $20 billion at each income level.
a. The aggregate expenditure line shifts upward by $8 billion, equilibrium real GDP demanded increases
by $80 billion, and the aggregate demand curve shifts to the right by $80 billion.
b. The aggregate expenditure line shifts downward by $5 billion, equilibrium real GDP demanded
decreases by $50 billion, and the aggregate demand curve shifts to the left by $50 billion.
c. The aggregate expenditure line shifts upward by $20 billion, equilibrium real GDP demanded increases
by $200 billion, and the aggregate demand curve shifts to the right by $200 billion.
Experiential Exercises
1. Professor Nouriel Roubini of New York University’s Stern School of Business maintains an extensive
website at https://www.roubini.com/ devoted to global financial issues and crises. Have students visit the
page to determine what the latest developments are around the world. What are the most significant issues?
Ask them to check it again at the end of the course and see what, if anything, has changed.
2. This chapter pointed out that net exports are an important influence on aggregate demand. Ask students to
find a story in today’s Financial Post, Globe and Mail, or National Post describing an event that will affect
Canadian imports or exports. They might also want to check out The Economist or the Wall Street Journal.
They should analyze the story they choose and illustrate the event using both the aggregate expenditure line
and the aggregate demand curve.
1. (Real GDP Demanded) In your own words, explain the logic of the income-expenditure model. What
determines the amount of real GDP demanded?
The quantity of real GDP demanded, given the price level, is found where aggregate expenditure equals real
GDP—that is, where desired spending equals the amount produced. Real GDP can be viewed as both the
value of aggregate output and as the aggregate income generated by that level of output. Because real GDP
is measured on the horizontal axis and aggregate expenditure is measured on the vertical axis, the graph of
the aggregate expenditure line drawn against a 45-degree line (representing points where real GDP and
expenditure are equal) is referred to as the income-expenditure model.
The quantity of real GDP demanded at a given price level occurs where real GDP, measured along the
horizontal axis, equals planned aggregate expenditure, measured along the vertical axis. This occurs where
the aggregate expenditure line intersects the 45-degree line.
2. (Real GDP Demanded) What equalities hold at the level of real GDP demanded? When determining real
GDP demanded, what do we assume about the price level? What do we assume about inventories?
Equilibrium occurs when the quantity of real GDP demanded equals real GDP. That is, C + I + G + (XM)
equals real GDP.
The price level is assumed to be constant. Unplanned inventories are assumed to vary to signal to firms when
they are overproducing or underproducing—inventories shrink when firms are underproducing and expand
when firms are overproducing.
3. (When Output and Spending Differ) What role do inventories play in determining the real GDP demanded?
In answering this question, suppose initially that firms are either producing more than people plan to spend
or producing less than people plan to spend.
Inventories play an essential role in the establishment of macroeconomic equilibrium. Suppose that firms are
currently overproducing. The managers of the firms will soon notice that inventories are piling up and will
reduce production. Over time, inventories fall if the rate of spending exceeds the rate of production.
4. (Simple Spending Multiplier) “A rise in investment in an economy leads to a rise in spending.” Use the
spending multiplier to verify this statement.
Consumption and investment are independent. However, if there is an increase in investment, real GDP will
rise, which in turn will cause consumption to rise. For example, suppose that the MPC is 0.90. If investment
were to rise by $10 billion, then we could expect income to rise by a total of $100 billion. Of this, $90 billion
would be multiplier-induced consumption spending.
5. (The Aggregate Demand Curve) What is the effect of a lower price level, other things constant, on the
aggregate expenditure line and real GDP demanded? How does the multiplier interact with the price change
to determine the new real GDP demanded?
If the price level falls, real wealth rises, the market interest rate falls, and foreign goods become relatively
expensive. Therefore, consumption, investment, and net exports rise, all of which shift the aggregate
expenditure line upward. Equilibrium real GDP demanded rises as well. The change in the quantity of real
GDP demanded equals the initial change in spending created by the price drop times the multiplier.
1. How do events such as the World Trade Center and Pentagon attacks described in the case study “Economic
Effects of Terrorism” affect the aggregate expenditure line and the aggregate demand curve? Explain fully.
The impact on Canada as well as in the United States is to reduce aggregate expenditure (shifts the AE curve
downward along the 45° line), thereby reducing aggregate demand (shifts the AD to the left). This reduction
relates to the negative impact on the airline industry and the ripple effect it has on the economy. The Canadian
economy was also negatively affected by border restrictions related to increased security reducing Canadian
exports to the United States.
1. According to the life-cycle hypothesis, what is the typical pattern of saving for an individual over his or her
lifetime? What impact does his behaviour have on an individual’s lifetime consumption pattern? What impact
does the behaviour have on the saving rate in the overall economy?
According to the life-cycle hypothesis, an individual will borrow when she is young when short of money,
save during middle age, and draw on savings when she is older. This has the effect of creating a more
balanced consumption profile over a person’s lifetime. According to this theory the saving rate depends on
the balance between savers and those who borrow and dissave.
Mr. Collins later withdrew from this company, and with “Tony” Nish
organized another “Christy” company, opening in London, England, at
Her Majesty’s Concert Hall Monday, March 18, 1861; subsequently he
sold his interest in this company, returned to London, and organized
another troupe; they played at Polygraphic Hall as early as April 14,
1862.
In September, 1863, he sailed for India, playing the principal cities. In
July, 1866, he returned to America, later going to England, where he
married; subsequently he returned to Pittsburgh, where he remained until
his death. He had not appeared professionally for several years prior to
that.
Mr. Collins did an “end”, a stump speech and a female impersonation
equally artistic.
W. P. Collins died at Pittsburgh, Pa., November 1, 1881; age about 55
years.
(GIRARD BROS.)
J. MELVILLE JANSEN GUS. BRUNO
P. S. G , who organized and led for many years the famous band
bearing his name, was a member of Ordway’s Aeolians in Boston, 1851,
where he sat on the end and played the tambourine. June 24, 1851, he
began an engagement in Hartford, Con., with the above company.
P. S. Gilmore was born near Dublin, Ireland, December 25, 1829; he
died at St. Louis, Mo., September 24, 1892.