Output and aggregate demand

True or false

1. When aggregate expenditure is greater than aggregate output, there will be an unplanned
build-up of inventories.
2. If actual investment is greater than planned investment, unplanned inventories decline.
3. If planned investment increases, equilibrium will be restored only when saving has increased
by exactly the amount of the initial increase in planned investment, assuming there is no
government or foreign sector.
4. When a closed economy without a government is in equilibrium, planned saving equals
planned investment.
5. If aggregate expenditure decreases, then equilibrium output increases.
6. Assuming there is no government or foreign sector, the economy will be in equilibrium if,
and only if, planned investment equals actual investment.
7. Actual investment equals planned investment plus unplanned changes in inventories.
8. If the MPC is 0,75, then the multiplier is 4.
9. The larger the MPC, the smaller the multiplier.
10. The paradox of thrift is that all people deciding to save more could lead to them saving
less.

Multiple Choice

1. The fraction of a change in income that is consumed or spent is called:

a) the marginal propensity of income.
b) the marginal propensity to save.
c) the marginal propensity to consume.
d) average consumption.

2. The MPC is:

a) the change in consumption divided by the change in income.
b) consumption divided by income.
c) the change in consumption divided by the change in saving.
d) the change in saving divided by the change in income.

3. Saving equals:
a) Y – C. b) Y – planned I. c) Y – actual I. d) Inventory changes.

4. If the MPS is 0,60, the MPC:

a) is 1,60.
b) 0,30.
c) is 0,40.
d) cannot be determined by the given information.

5. If you earn additional $500 in disposable income one week for painting your neighbors’
house:
a) the total of your consumption and saving will increase by more than $500.
b) the total of your consumption and saving will increase by $500.
c) the total of your consumption and saving will increase by less than $500.
d) your consumption will increase by more than $500, even if your MPS is 0,1.

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6. If the consumption function is below the 45-degree line:
a) consumption is less than income and saving is positive.
b) consumption is less than income and saving is negative.
c) consumption exceeds income and saving is positive.
d) consumption exceeds income and saving is negative.

7. Which of the following is NOT considered investment?

a) The acquisition of capital goods.
b) The purchase of government bonds.
c) The increase in planned inventories.
d) The construction of a new factory

8. In one year, a firm increases its production by $9 million and increases sales by $8 million.
All other things in the economy remaining the same, which of the following is true?
a) GDP increases by $8 million and inventory investment decreases by $1 million.
b) GDP increases by $9 million and inventory investment increases by $1 million.
c) Inventory investment decreases by $1 million.
d) GDP increases by $8 million and investment increases by $1 million.

9. If planned investment exceeds actual investment,

a) there will be an accumulation of inventories.
b) there will be no change in inventories.
c) there will be a decline in inventories.
d) none of the above

10. If Inventory investment is higher than firms planned,

a) actual and planned investment are equal.
b) actual investment is less than planned investment.
c) actual investment is greater than planned investment.
d) actual investment must be negative.

11. In a closed economy with no government, aggregate expenditure is:

a) consumption plus investment.
b) saving plus investment.
c) consumption plus the MPC.
d) MPC + MPS.

12. Net exports of goods and services is equal to the value of:
a) exports plus the value of imports.
b) imports minus the value of exports.
c) domestic consumption minus the value of imports.
d) exports minus the value of imports.

13. Total expenditure in an open economy is equal to consumption plus investment:

a) plus government expenditure on goods and services plus imports of goods and services.
b) minus government expenditure on goods and services minus imports of goods and
services.
c) plus government expenditure on goods and services plus exports of goods and services.
d) plus government expenditure on goods and services plus exports minus imports.

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14. The relationship between real GDP and potential GDP over the business cycle can be best
summarized by which of the following statements?
a) Real GDP fluctuates around potential GDP.
b) Real GDP is always equal to potential GDP.
c) Real GDP cannot be greater than potential GDP.
d) Real GDP cannot be less than potential GDP.

15. In macroeconomics, equilibrium is defined as that point at which:

a) saving equals consumption.
b) planned aggregate expenditure equals aggregate output.
c) planned aggregate expenditure equals consumption.
d) aggregate output equals consumption minus investment.

16. If aggregate output is greater than planned spending, then:

a) unplanned inventory investment is zero.
b) unplanned inventory investment is negative.
c) unplanned inventory investment is positive.
d) actual investment equals planned investment.

17. A decrease in planned investment causes:

a) output to increase.
b) output to decrease, but by a smaller amount than the decrease in investment.
c) output to decrease, but by a larger amount than the decrease in investment.
d) output to decrease by an amount equal to the decrease in investment.

18. If C = 100 + 0,8Y and I = 50, then the equilibrium level of income is:
a) 600. b) 375. c) 187,5. d) 750.

19. If C = 500 + 0,9Y and I = 400, then the equilibrium level of income is:
a) 900. b) 1800. c) 1000. d) 9000.

20. If S = -200 + 0,2Y and I = 100, then the equilibrium level of income is:
a) 3000. b) 1500. c) 4000. d) 1200.

21. According to the ʺparadox of thrift,ʺ as individuals increase their saving:

a) income in the economy increases because there is more money available for firms to
invest.
b) income in the economy increases because interest rates will fall and the economy will
expand.
c) income in the economy will remain constant because the change in consumption equals
the change in saving.
d) income in the economy will fall because the decreased consumption that results from
increased saving causes the economy to contract.

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Problems
1. Refer to the information provided in figure below to answer the questions that follow.

a) The equation for the aggregate consumption function is:

a) C = 140 + 0,5Y. b) C = 60 + 0,7Y. c) C = 80 + 0,60Y. d) C = 60 + 0,4Y.

b) The equation for the aggregate saving function is:

a) S = -60 + 0,3Y. b) S=-200 + 0,6Y. c) S=-140 + 0,5Y. d) S = -80 + .4Y

c) In this economy, aggregate saving will be zero if income is:

a) $100 billion. b) $200 billion. c) $300 billion. d) $400 billion.

2. Refer to the information provided below to answer the questions that follow.

All Figures in Billions of Dollars

Aggregate Output Aggregate Consumption Planned Investment
200 300 100
400 450 100
600 600 100
800 750 100
1,000 900 100

a) At an aggregate output level of $400 billion, planned expenditure equals:

a) $550 billion. b) $450 billion. c) $500 billion. d) $850 billion.

b) At an aggregate output level of $800 billion, aggregate saving:

a) equals -$50 billion. b)equals $0. c)equals $50 billion. d) cannot be determined
from this information.

c) At an aggregate output level of $200 billion, the unplanned inventory change is:
a) -$150 billion. b) -$200 billion. c) -$50 billion. d) $100 billion.

d) At an aggregate output level of $600 billion, the unplanned inventory change is:
a) -$100 billion. b) -$50 billion. c) $0. d) $50 billion.

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e) If aggregate output equals ________, there will be a $100 billion unplanned decrease in
inventories.
a) $200 billion. b) $400 billion. c) $600 billion. d) $800 billion

f) The equilibrium level of aggregate output equals:

a) $400 billion. b) $600 billion. c) $800 billion. d) $1,000 billion.

3. Suppose the consumption function is C = 0.8Y and planned investment is 40. (a) Draw a
diagram showing the aggregate demand schedule. (b) If actual output is 100, what unplanned
actions will occur? (c) What is equilibrium output? (d) Do you get the same answer using
planned saving equals planned investment?

4. Suppose the MPC is 0.6. Beginning from equilibrium, investment demand rises by 30. (a)
How much does equilibrium output increase? (b) How much of that increase is extra
consumption demand?

5. (a) Show the answer to question 4 in a diagram (b) Draw the corresponding diagram using
planned investment and planned saving. (c) Is the answer the same? Why or why not?

6. Planned investment is 100. People decide to save a higher proportion of their income: the
consumption function changes from C = 0.8Y to C = 0.5Y. (a) What happens to equilibrium
income? (b) What happens to the equilibrium proportion of income saved? Explain.

7. What part of actual investment is not included in aggregate demand?

8. (a) Find equilibrium income when investment demand is 400 and C = 0.8Y. (b) Would output
be higher or lower if the consumption function were C = 100 + 0.7Y?

9. Planned investment is 100. Initially, the consumption function is C = 100 + 0.8Y. There
are three ways in which greater pessimism about the future might affect behaviour: (a) Planned
investment falls from 100 to 50 (b) autonomous consumption falls from 100 to 50. (c) The
marginal propensity to consume falls from 0.8 to 0.7 as people save more of each unit of
additional income. Draw a graph of each change and its effect on short-run equilibrium output.

10. Consider a model for a closed economy with no government. Suppose the consumption
function is given by C = 100 + 0.8Y, while investment is given by I = 50.
a) What is the equilibrium level of income?
b) What is the level of saving in equilibrium?
c) If, for some reason, output is at the level of 800, what will the level of involuntary
inventory accumulation be?
d) What is the value of the multiplier?
e) If I rises to 100, what will the effect be on the equilibrium income?
f) Draw a diagram indicating the equilibria in both (a) and (e).

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11. In some "Keynesian" closed economy with no state, the consumption function has the
formula: Cpl = 0.7. Y – 10 (Y is disposable income), and planned investment, Ipl , equals 60.
Firms decide to produce an output of 100, and their stocks of finished goods are: (1) 20; (2) 0;
(3) 10. a) For each of the options (1), (2), (3) answer the question how much are the planned
savings, Spl , and the planned investments, Ipl . b) For each of the situations (1), (2), (3) answer
the question how much are the actual savings, S, and the actual investments, I. c) How is it
possible that in such an economy only sometimes Ipl ≠ Spl , but always I = S?

12. Suppose we have a closed two-sector economy, where the consumption function is C =
0.7Yd, where Yd is disposable income, and investment, I, is equal to 60.
a) Calculate output in equilibrium.
b) Calculate the level of savings.
c) Suppose that households decide to raise their savings by 10. Calculate the new output
in equilibrium.
d) Calculate the new level of savings.
e) Using the situation from above, explain the paradox of thrift. Does that mean that the
less societies save, the better for them?