Answers to Exercises

1. Inventories always act to make up for any difference between expenditures and income. Whenever income is greater than expenditures, businesses realize increases in inventories that make actual expenditures equal to income. When income is less than expenditures, inventories fall until actual expenditures equal actual income.

2.

The equilibrium level of real GDP is $500 and the multiplier is 10. Since the MPS is .3, the multiplier is 3.33.

3.

4. a. 5
b. 2.5
c. 2
d. 10

5.

6. When the domestic economy expands, the demand for imports increases. This leads to the expansion of foreign economies, which leads in turn to additional demand for the output of the domestic economy by foreigners. Because of this, the actual multiplier is larger than that implied by our model.

7. In this case the multiplier is [MAKE GRAPHIC FROM SCREENSHOT!!!].

8. .9

9. .1

10. .1

11. 5

12. $500 - the point where AE = Y

13. $30

14. $600

15. C = $30 + .9Y X = $20 - .1Y AE = $100 + .8Y

16. See Figure 6 in the text for an example of the derivation. Each point on the aggregate demand curve corresponds to an aggregate expenditures equilibrium at a particular price level. Movements along the aggregate demand curve correspond to the aggregate expenditure line moving along the 45-degree line in response to a changing price level.

Answers to Study Guide Homework

1. Real GDP

2. Saving, taxes, imports

3. Investment, government spending, exports

4. The initial $50 billion spent on new business investment will generate $50 billion in additional income for people in the economy. These people will save some of their added income, but will use some of it to buy additional goods and services. This second-round buying creates additional income for another group of people, who in turn buy more goods and services. The initial $50 billion in increased spending is multiplied by these additional rounds of income and spending.

5. An increase in interest rates would decrease investment, leading to lower aggregate expenditures and lower real GDP, as shown on the diagram. A drop in real GDP would hurt a president's chances of reelection.

Answers to Internet Exercise

This exercise will teach your students how to access economic data for foreign countries. After completing the exercise they will be able to determine the ratio of (exports to the U.S.)/GDP for a variety of countries and by doing so predict which countries would be more sensitive to changes in U.S. income.

1.
Germany: 7.3% x $501.3 billion = $36.6 billion
Japan: 27% x $385 billion = $103.95 billion
Mexico: 80% x $95 billion = $76 billion

2.
Germany: $36.6 billion / $1.7 trillion = 2.15%
Japan: $103.95 billion / $2.85 trillion = 3.65%
Mexico: $76 billion / $777.3 billion = 9.78%

3. Ranking:
1 - Mexico, 9.78%
2 - Japan, 3.65%
3 - Germany, 2.15%

Note: All numbers are based on 1996 estimates, subject to revision and updating.