1. 1 Chapter 18 Tutorial The Keynesian Model ©2000 South-Western College Publishing

2. 2 1. The French classical economist Jean Baptiste Say transformed the equality of production and spending into a law that can be expressed as follows: a. The invisible hand creates its own supply. b. Wages always fall to the subsistence level. c. Supply creates its own demand. d. Aggregate output does not always equal consumption. C. Says law was developed in the early 1800s and is the cornerstone of classical economics.

3. 3 2. Autonomous consumption is a. positively related to the level of consumption. b. negatively related to the level of consumption. c. positively related to the level of disposable income. d. independent of the level of disposable income. D. Autonomous consumption is the amount of spending from savings or borrowing that occurs even when disposable income is zero.

4. 4 3. The consumption function represents the relationship between consumer expenditures and a. interest rates. b. saving. c. the price level. d. disposable income. D. Keynes argued the most important determinant of aggregate spending for consumer goods is personal income after taxes.

5. 5 4. John Maynard Keynes’s proposition that a dollar increase in disposable income will increase consumption, but by less than the increase in disposable income, implies a marginal propensity to consume that is a. greater than or equal to one. b. equal to one. c. less than one, but greater than zero. d. negative. C. Each dollar change in disposable income is divided between changes in consumption and saving.

6. 6 5. Above the break-even disposable income for the consumption function, which of the following occurs? a. Dissaving. b. Saving. c. Neither (a) nor (b). d. Both (a) and (b). B. Dissaving occurs below the break-even point on the consumption function.

7. 7 4 3 2 1 1234 5 6 7 8 5678910 Dissaving Saving C Real Consumption Trillions of $ per year Real Disposable Income Trillions of $ per year CC YdYd C = Y d 45° The Consumption Function 9 10 0

8. 8 6. Which of the following changes produces an upward shift in the consumption function? a. An increase in consumer wealth. b. A decrease in consumer wealth. c. A decrease in autonomous consumption. d. Both (b) and (c). A. Decreases in wealth and autonomous consumption shift the consumption function downward.

9. 9 4 3 2 1 1 23 4 5 6 7 8 5 6 78 C=Y d C1C1 910 9 0 The Consumption Function Real Consumption trillions of $ per year 45 o Real Disposable Income trillions of $ per year

10. 10 4 3 2 1 1 23 4 5 6 7 8 5 6 78 C=Y d C2C2 910 9 0 The Consumption Function Real Consumption trillions of $ per year 45 o Real Disposable Income trillions of $ per year C1C1

11. 11 7. An upward shift in the consumption schedule, other things being equal, could be caused by households a. becoming optimistic about the state of the economy. b. becoming pessimistic about the state of the economy. c. expecting future income and wealth to decline. d. none of the above. A. If consumers expect good economic ties ahead, they increase spending at each level of disposable income in the current time period.

12. 12 8. The investment demand curve represents the relationship between business spending for investment goods and a. GDP. b. interest rates. c. disposable income. d. saving. B. As the interest rate declines, more business investment projects become profitable and investment spending increases.

13. 13 16% 12% 8% 4% 5 10 1520 Interest rate Shift in the firm’s investment demand curve I1I1 Real investment

14. 14 9. Which of the following changes produces a leftward shift in the investment demand curve? a. A wave of optimism about future profitability. b. Technological change. c. High plant capacity utilization. d. An increase in business taxes. D. Technological change and high plant capacity increase the investment curve. An increase in business taxes decreases after-tax profits on investment projects and businesses invest less at various possible interest rates.

15. 15 16% 12% 8% 4% 5 10 1520 Interest rate Shift in the firm’s investment demand curve I1I1 Real investment

16. 16 16% 12% 8% 4% 5 10 1520 Interest rate Shift in the firm’s investment demand curve I2I2 I1I1 Real investment

17. 17 10. The aggregate expenditures function (AE) represents which of the following? a. The consumption function only. b. Autonomous consumption only. c. The investment demand curve only. d. All three of the above combined. e. A combination of (a) and (c). D.

18. 18 4 3 2 1 1 23 4 5 6 7 8 5 6 78 AE C C + I E Real Disposable Income trillions of dollars per year 910 9 0 Exhibit 11 Aggregate Expenditures Schedule and Function Investment Autonomous Consumption

19. 19 11. In Exhibit 11, what is the households’ marginal propensity to consume (MPC)? a. 0.5. b. 0.67. c. 0.75. d. 0.80. A. MPC is the change in consumption divided by the change in disposable income. In this case, the change in consumption to disposable income is three to six, or 0.50. (hint: start at autonomous consumption of $2 trillion)

20. 20 12. In Exhibit 11, aggregate disposable income will equal consumption plus investment (aggregate expenditures) and the economy will be in equilibrium when real disposable income is a. $2.33 trillion. b. $3 trillion. c. $6 trillion. d. $10 billion. C. The AE curve crosses the 45 degree line at $6 trillion.

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