Explain how automatic stabilizers work, both on the taxation side and on the spending side, first in a situation where the economy is producing less than potential GDP and then in a situation where the economy is producing more than potential GDP.

nn1. A hypothetical economy’s consumption schedule is given in the table below.n

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GDP=DI	C
6600	6680
6800	6840
7000	7000
7200	7160
7400	7320
7600	7480
7800	7640
8000	7800

nUse the information to answer the following:n

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1. If disposable income were $7400, how much would be saved?

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1. What is the “break-even” level of disposable income?

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1. What is this economy’s marginal propensity to consume?

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1. What is the average propensity to consume when disposable income is $7000? When disposable income is $8000?

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n2. Multiplier effect.n

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1. Suppose a $100 increase in desired investment spending ultimately results in a $300 increase in real GDP. What is the size of the multiplier?

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1. If the MPS is .4, what is the multiplier?

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1. If the MPC is .75, what is the multiplier?

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1. Suppose investment spending initially increases by $50 billion in an economy whose MPC is 2/3. By how much will this ultimately change real GDP?

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nnn3. The consumption and investment schedules for a private closed economy are given in the following table:n

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GDP=DI	C	I
6600	6680	80
6800	6840	80
7000	7000	80
7200	7160	80
7400	7320	80
7600	7480	80
7800	7640	80
8000	7800	80

nUse the values in the table to answer the following:n

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1. What is the equilibrium level of GDP?

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1. What is the level of saving at the equilibrium level of GDP?

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1. Suppose actual GDP is $7600. How much unplanned inventory change will occur? What will likely happen to GDP as a result?

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n4. Suppose a private closed economy has an MPC of .8 and a current equilibrium GDP of $7400 billion.n

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1. What is the multiplier in this economy?

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1. Now suppose the economy opens up trade with the rest of the world and experiences net exports of $20 billion. What impact will this have on equilibrium real GDP?

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1. Next suppose a government is introduced and plans to spend $100 billion. By how much will this change in spending ultimately cause GDP to change, and in what direction?

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1. In order to finance this expansion of government spending, suppose the government decides to levy a lump-sum tax of $100 billion. By how much will GDP change, and in what direction?

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n5. Suppose an economy can be represented by the following table, in which employment is in millions of workers and GDP and AE are expressed in billions of dollars:n

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Employment		Real GDP		Aggregate Expenditures
100		1200		1275
105		1300		1350
110		1400		1425
115		1500		1500
120		1600		1575
125		1700		1650

nUse the table to answer the following:n

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1. What is the equilibrium level of GDP?

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1. What kind of expenditure gap exists if full employment is 120 million workers? What is its size?

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1. Suppose government spending, taxes, and net exports are all independent of the level of real GDP. What is the multiplier in this economy?

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1. Suppose instead that the economy is producing at equilibrium GDP. If this GDP is $200 billion below the economy’s potential, what is the size of the recessionary expenditure gap?

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nFiscal Policynn6. When governments run budget deficits, how do they make up the differences between taxnnrevenue and spending?nn7.What are the two tools of fiscal policy?nnnn8. A government starts off with a total debt of $3.5 billion. In year one, the government runs anndeficit of $400 million. In year two, the government runs a deficit of $1 billion. In year three,nnthe government runs a surplus of $200 million. What is the total debt of the government atnnthe end of year three?nn9. Explain how automatic stabilizers work, both on the taxation side and on the spending side, first in a situation where the economy is producing less than potential GDP and then in a situation where the economy is producing more than potential GDP.nn10. What is the difference between a budget deficit, a balanced budget, and a budget surplus?nn