594 PA R T V I I Monetary Theory KEY TERMS aggregate demand, p 573 consumption function, aggregate demand function, p 577 disposable income, animal spirits, p 581 autonomous consumer expenditure, p 574 consumer expenditure, p 573 p 574 p 574 expenditure multiplier, p 578 IS curve, LM curve, p 587 p 587 fixed investment, p 575 marginal propensity to consume, p 574 government spending, p 573 net exports, p 573 inventory investment, planned investment spending, p 573 p 575 QUESTIONS You will find the answers to the questions marked with an asterisk in the Textbook Resources section of your MyEconLab If the marginal propensity to consume were 0.5, how much would government spending have to rise in order to raise output by $1000 billion? *2 Suppose that government policymakers decide that they will change taxes to raise aggregate output by $400 billion, and mpc * 0.5 By how much will taxes have to be changed? What happens to aggregate output if both taxes and government spending are lowered by $300 billion and mpc * 0.5? Explain your answer *4 Will aggregate output rise or fall if an increase in autonomous consumer expenditure is matched by an equal increase in taxes? If a change in the interest rate has no effect on planned investment spending, trace out what happens to the equilibrium level of aggregate output as interest rates fall What does this imply about the slope of the IS curve? *6 Using a supply and demand diagram for the market for money, show what happens to the equilibrium level of the interest rate as aggregate output falls What does this imply about the slope of the LM curve? If the point describing the combination of the interest rate and aggregate output is not on either the IS or the LM curve, the economy will have no tendency to head toward the intersection of the two curves Is this statement true, false, or uncertain? Explain your answer Q U A N T I TAT I V E P R O B L E M S Calculate the value of the consumption function at each level of disposable income in Table 22-1 (page 574) if a * 100 and mpc * 0.9 *2 Why companies cut production when they find that their unplanned inventory investment is greater than zero? If they didn t cut production, what effect would this have on their profits? Why? Plot the consumption function C * 100 + 0.75Y on graph paper a Assuming no government sector, if planned investment spending is 200, what is the equilibrium level of aggregate output? Show this equilibrium level on the graph you have drawn b If businesses become more pessimistic about the profitability of investment and planned investment spending falls by 100, what happens to the equilibrium level of output? *4 If the consumption function is C * 100 + 0.8Y and planned investment spending is 200, what is the equilibrium level of output? If planned investment falls by 100, how much does the equilibrium level of output fall? Why are the multipliers in Problems and different? Explain intuitively why one is higher than the other *6 If firms suddenly become more optimistic about the profitability of investment and planned investment spending rises by $100 billion, while consumers become more pessimistic and autonomous consumer spending falls by $100 billion, what happens to aggregate output? A rise in planned investment spending by $100 billion at the same time that autonomous consumer expenditure falls by $50 billion has the same effect on aggregate output as a rise in autonomous consumer expenditure alone by $50 billion Is this statement true, false, or uncertain? Explain your answer