Exercise Set 11
THE MULTIPLIER

I. Objectives

• To compute equilibrium GDP
• To compute the multiplier

II. Data

Assumptions

• Consumption: C = a + b(DI)
• Investment (I), Government expenditure (G), Net Exports (X-IM), and Taxes (T) are exogenous.

Steps

• Assume values of the parameters (a and b).
• Assume values of the exogenous variables (I, G, X-IM and T).
• Solve for equilibrium values of GDP, DI, C and S.
• Compute the investment multiplier.
• Click on Gimme Multiplier! to confirm.

III. Questions

1. Assume particular values for the parameters of the consumption function:
   
   
   a = 14000, b = 0.75
   
   
2. Assume particular values for the exogenous variables:
   
   
   I = 850, G = 1000,   X-IM = 300, T = 600   

3. Obtain the equation for aggregate expenditure (in terms of Y):
   
   AE =
   
   
4. Obtain the equilibrium values of the endogenous variables (show your calculations):

   GDP =     Disposable income =    
   
   Consumption =     Saving =

5. Sketch the income-expenditure diagram.
   
   • Indicate the intercepts and slope of the C-line and AE-line.
   • Indicate the eqbm values of Y and C on the graph.

6. Suppose private firms increase their spending on capital goods by 10%.
   • The new value of I is .

   • The new equilibrium values of the endogenous variables are:

     GDP =     Disposable income =    
     
     Consumption =     Saving =

7. Sketch the corresponding changes in the income-expenditure diagram.
   
   
8. Compute the value of the investment multiplier: .
   
   
9. The investment multiplier is (greater than | less than | equal to) 1/MPS.
   
   
10. Compute the government spending multiplier:
    
    
11. The government multiplier is (greater than | less than | equal to) 1/MPS.
    
    
12. Compute the tax multiplier:
    
    
13. The tax multiplier is (greater than | less than | equal to) 1/MPS.
    
    
14. The government spending multiplier is (greater than | less than | equal to) the tax multiplier. Why?
    
    
15. Compute the export multiplier:
    
    
16. Which of the following will have the smallest impact on GDP? (a) X-IM increases by 200. (b) G increases by 200. (c) T decreases by 200.
    
    Answer: