David K.H. Begg, Gianluigi Vernasca-Economics-McGraw Hill Higher Education (2011)

Review questions
2 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?
3 Planned investment is 100. People decide to save a higher proportion of their income: the
consumption function changes from C = 0.8Y to C = O.SY. (a) What happens to equilibrium
income? (b) What happens to the equilibrium proportion of income saved? Explain.
4 What part of actual investment is not included in aggregate demand?
5 (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?
6 Common fallacies Why are these statements wrong? (a) If people were prepared to save more,
investment would increase and we could get the economy moving again. (b) Lower output leads to
lower spending and yet lower output. The economy could spiral downwards for ever.
7 Which is correct? (a) Any tax is a tax on jobs because it reduces aggregate demand. (b) Provided
the government spends the tax revenue, the impact of higher spending outweighs the adverse
demand effect of higher taxes. (c) When autonomous consumption demand is adversely influenced
by fears about the future consequences of a large budget deficit, an increase in taxes could stimulate
demand by boosting autonomous consumption demand. (d) All of the above statements could be
true, depending on the other things assumed equal.
8 Suppose firms are initially surprised by changes in demand. (a) When demand falls, what is the
initial effect on stocks of unsold goods held by firms? (b) What do firms plan to do to stocks as soon
as they have time to adjust production? Does this reduce or increase the initial fall in demand?
(c) Once stocks have been adjusted, what then happens to production and output?
9 (a) Show the answer to Question 2 in a diagram. (b) Draw the corresponding diagram using
planned investment and planned saving. (c) Is the answer the same? Why or why not?
l 0 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.
11 Suppose confidence depends a little on the current level of output, and the model therefore becomes
l=aY+I*
C =A + c Y = [A* + b Y] + c Y
where I* and A* remain autonomous and independent of output, but a and b reflect the dependence
of confidence on the current level of output. (a) What is the new value of the multiplier? (b) Is this
higher or lower than before? (c) Is equilibrium output higher or lower than before?
l 2 Could the multiplier ever be less than 1?
13 When could the paradox of thrift fail to be true?
14 Essay question 'The remarkably strong relationship between consumption and income confirms
that most people want to spend most of their income as soon as they can. We are all material girls
and boys at hearf Is the inference justified?
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