'J)o aUtuxoa-/ q,rr"*{fAsl4 #S- CHAPTER 12 Spending by lndividuals, Firms, and Governments on Real Goods and Services 359 f-,LI Given the following variables in the open econ- omy aggregate expenditure model, autonomous consumption (Co) * 2A0, autonomous invest- ment (16) = 200, government spending (Gd = 100, export spending (Xo) = 100, autonomous import spending (Mil = 100, taxes (Tp) = 0, marginal pro. penstty to consume (cJ = 0.8, marginal propen- sity to invest (iJ = 0"1, and marginal propensity to import @nt) = 0-15, a Calculate the equilibrium level of income for the open economy aggregate expenditure model. b. If there is an increase in autonomous import expenditure from 100 to 200 resulting from arr increase in the currency exchange rate, calcu- late the new equilibrium level of income and the value of the multiplier. c. Compared with the original equilibrium in part a, if the goyernrnent decides to impose taxes {Tp) of 100, ca}culate the new equilibrium level of income. ffi Application Questions 1. [Jse the aggregate expenditure model developed in this chapter to explain the following statements: a Coming amid continued turmoil in the finan- cial and credit markets, the report sent stocks lower, with the Dow Jones Industrial Average fatling 146.70 points F?idayto close at 11,899.69. b. Administration offlcials said they were confi- dent conditions would improve as tax rebates that are part of the recent $152 billion economic- stimulus package begin to reach consumers. c. The Fed is expected to cut interest rates again to prop up the economy. 2. Redraw Figures l2.11aand 12.11b to illustrate the effects on the resulting equilitrrium level of income trom ea,ch of the following changes: a A greater sensitivity of interest-related con- sumption and investment expenditure to changes in the interest rate. b. A larger multiplier in the aggregate expenditure model. Hint: Remember that consumption has an auton- omous component and is a firnction of dispos- able income, Iz4, where Ya= Y - Tp. the consumption ion is given by C = 800 + 0.8 {Y - T1), that nt (1) equals 200, and that government (G) and taxes (7p) or export spending. a. Calculate the equilibrium lncome. b. If government purchases crease by 100 (all else held constant), the new equi- librium level of ue of the multiplier. c. Compared with government nditure (G) and Qp) so that the government budget remalns anced, does the equilibrium level remain unchanged? Explain your "r'';+ 3. Go to the Web site of the Conference Board (www.conference-board.org) and find the latest release of the Consumer Confidence Index. I{ow has the index changed since its last release? What is the expected impact of this change on the economy? 4. A number of articles in the Watl Street Jou,mraL reported that the strong dollar, combined with the recession of 2001, fbrced many U.S. manu- facturers to develop better methods to produce and sell their products. Usc the discussion of the nlacr ...

1. 'J)o aUtuxoa-/ q,rr"*{fAsl4 #S-
CHAPTER 12 Spending by lndividuals, Firms, and Governments
on Real Goods and Services 359 f-,LI
Given the following variables in the open econ-
omy aggregate expenditure model, autonomous
consumption (Co) * 2A0, autonomous invest-
ment (16) = 200, government spending (Gd = 100,
export spending (Xo) = 100, autonomous import
spending (Mil = 100, taxes (Tp) = 0, marginal pro.
penstty to consume (cJ = 0.8, marginal propen-
sity to invest (iJ = 0"1, and marginal propensity
to import @nt) = 0-15,
a Calculate the equilibrium level of income for the
open economy aggregate expenditure model.
b. If there is an increase in autonomous import
expenditure from 100 to 200 resulting from arr
increase in the currency exchange rate, calcu-
late the new equilibrium level of income and
the value of the multiplier.
c. Compared with the original equilibrium in part
a, if the goyernrnent decides to impose taxes
{Tp) of 100, ca}culate the new equilibrium level
of income.
ffi
Application Questions
1. [Jse the aggregate expenditure model developed in

2. this chapter to explain the following statements:
a Coming amid continued turmoil in the finan-
cial and credit markets, the report sent stocks
lower, with the Dow Jones Industrial Average
fatling 146.70 points F?idayto close at 11,899.69.
b. Administration offlcials said they were confi-
dent conditions would improve as tax rebates
that are part of the recent $152 billion economic-
stimulus package begin to reach consumers.
c. The Fed is expected to cut interest rates again
to prop up the economy.
2. Redraw Figures l2.11aand 12.11b to illustrate the
effects on the resulting equilitrrium level of income
trom ea,ch of the following changes:
a A greater sensitivity of interest-related con-
sumption and investment expenditure to
changes in the interest rate.
b. A larger multiplier in the aggregate expenditure
model.
Hint: Remember that consumption has an auton-
omous component and is a firnction of dispos-
able income, Iz4, where Ya= Y - Tp.
the consumption ion is given by C = 800 + 0.8
{Y - T1), that nt (1) equals 200,
and that government (G) and taxes (7p)
or
export spending.

3. a. Calculate the equilibrium lncome.
b. If government purchases crease by 100
(all else held constant), the new equi-
librium level of ue of the
multiplier.
c. Compared with
government nditure (G) and Qp)
so that the government budget
remalns anced, does the equilibrium level
remain unchanged? Explain your
"r'';+
3. Go to the Web site of the Conference Board
(www.conference-board.org) and find the latest
release of the Consumer Confidence Index. I{ow
has the index changed since its last release?
What is the expected impact of this change on
the economy?
4. A number of articles in the Watl Street Jou,mraL
reported that the strong dollar, combined with
the recession of 2001, fbrced many U.S. manu-
facturers to develop better methods to produce
and sell their products. Usc the discussion of the
nlacro model in this chaptcr to explain why busi-
nesses would have implemented such changes in
strategies.
5. What were the key provisions of the American
Recovery and Reinvestment Act passed by

4. Congress in February 2009? How has the impact of
the Act been evaiuated?
6. Compare and contrast current U.S. economic
activity with that described in the opening case of
this chapter.
Economics for Managers, Third Edition, by Paul G. Famham.
Published by Prentice Hall. Copyright O 2014 by pearson
Education, Inc.
each equai 200.
l-
W 358 PAffi;:iMacroeconomicAnalysis
L2.BL2 E .
12.813 fi =
'tDh,sre
n_D0-
Ct:
;-t,l -
wlt:
gross private domestic investmenL
p.332
induced <onsumption enpenditures,
p.332

5. injections, p.347
interest-related expenditure (lBE)
function, p.352
investment spending function, p. 340
leakages, p.347
marginal propensigr to consume
(MPC),p,324
marginal propensity to save (/!lPS) ,
p.325
Multiplier, p.351
,r ;, ;r*," ,.. ".."",]
.,.'..-;.:.l';
net export expenditure, p.342
nominal interest rate, p. 327
nominal terms, p.323
personal consumption expenditure,
p.324
potential GDB p.322
rea! i nterest rate, p. 327
real terms, p.323

6. relative prices, p.335
saving (5), p.325
unplanned inventory decrease,
p.349
unplanned inventory increase,
P.349
Exercises
Tbehnical Questions
The real interest rate increases.
Consumer confi dence decreases.
Higher taxes are imposed on business profits.
The economies of many countries in the rest of
the world go into recessions.
.,. e*%q{ffi
the following statements as to whether
a. The
have a
than changes confidence.
b. Both an increase government spending (G)
and an increase taxes (7p) will shift
the aggregate function in the same
direction.
c. The nationr ts show that real
lncome always equals expenditure
(E), giu the dqfinition of the ci,rcular floro

7. af econfimic a,cti,aitg. Thus, the economy must
utwayb'be in equilibrium because that is also
where I/= E
a.
b.
C.
d.
af- ,--')-),-s -kahn, L4L @t zzti*-* u-, #3
Ca + Io+ Go + & - Mo + crY + irY - mrY
.E6*(c1 *-m1)Y
lco+ Io + Go + xo- Mol
marginal propenslty to consume
marginal propensity to invest
marginal propensity to import
Key Terms
aggregate expenditure, p. 324
aggregate expenditure function, p. 345
autonomous consumption
expendltures, p.332
budget surplus/deficit, p. 341
capacity utilization rates (CUBsl, p. 337

8. Consumer Confidence lndex (CCD , p.327
Consurner Sentiment lndex (CSA, p. 327
consumptian function, P. 324
currency exchange rate, p.343
equilibrium level of income and
outpuL p.347
fiscal pollcy, p.341
government expenditurg p. 341
the difference
fand which are no=tRQnlain your answer.
the effect of the curreicy exchange rate
Economics for Managers, Third Edition, by Paul G. Farnham.
Published by Prentice Hall. Copyright O 2014 by Pearson
Education, lnc.
ing variables:
meals that changes in weall.h
Qr
Application Questions
Drawing on current business publications and
tying the opening case of the chapter as a guide,

9. discuss how the slow economi" ,u"olr"ry in 201I
and 2412 has affected the cument straiegies of
flrms other than those mentioned in the cas-e.
Wl,ealwv *@A/kv # I
CHAPTER t 1 Measuring Macroeconomic Activity 3Lg ,Eil
a. Howi CPI used?
b. How is CPI market basket determined?
What and services does the CpI cover?
How are prices collected and reviewed?
From the tics Web page
(wwwbls.gov , find annual averages of
the emplo;rment of the civilian noninsti-
1940 to date. Constructtutional population
C.
d.
(ro,
a table and chart
noninstitutional
force, the num ofe
1969, 1982,
Discuss
time peri
the size of the civilian
on, the civilian labor

10. , the number of
20A7, and ZAtl.
these variables di,$ered in thoser). Ftom the Bureau of Econffic
Analysis Web page
(wwl,r.,.bea.gov), construct"a table showing the/". 7.
Ftomanrru{ percentage cydrge ih.real GDi gross pri_
Web sivate domestic inveritfnent @,'ngnresid"ritiui fix"a
11y9.ftn9nt, and pdsidential fixed..inveshnent from
re these revisions for your example?
Bureau of Lalror Statistics Web page
(u.ww.bls.gov/cpi), find the answers to the foilow_
ing questions:
years? Are there c
among those
of trade
ning
ZC0Z to 2A11. Vnch component of investment had
which was the shortest?the greatest impact on the recession
of2007 to 200g?
4. md.T arfcte in a current business publication on current
business publications, find an
3:r^9"-?4"esrevisiors in the GDp aata How sig_
cle in which either fiscal or monetary policy
were describing their goals of maintain_

11. (www.nber.org), flnd the official begin-
ending dates of the recessions that hive
since 1965. Which recession was the lon_
ing stable prices, full emploS.ment, and adequate
economic growth over time. Which goal was
the most important at the time your u.ii"l" -*written?
Do the percentagesr cor spent on
(6), investment (I), fuvernment (G)
and imports (/fl diffesignifican
Economics for Managers' Third Edition, by Paul G. Farnham.
Published by prentice Hall. copyright @ 2014 by pearson
Education, Inc.
1980, 1990, 2000, and 2010. Show the
change in real over each of those
unemployed,
over the period?
Bureau or s"on}ri" Besearch
Dy
)cdn r-n4l $1 ,"aa&* */
IE 3fB PART2 MacroeconomicAnalysis
Exercises
Teehnical Questions
1. Do government statisticians

12. ply adding up the total sales of
in one year? Explain.
2. Evaluate whether oIJ of following are
ered to be investment in calculating GDP.
a. The purchase new automobile for
nonlrusiness
5.
6.
Is real GDP defined as "the value of aggregate out-
full emplo;rment"?
Suppose an economy ces only two goods,
cups of coffee
Table 11.E1:
ons of milk, as_
expenditure good and the
and real GDP 10, the base year.
this each of the three alter-
hrplain the between nominal GDP
and real GDP in each ofthese cases.
Adding to Thble 11.1, if in 2007 real GDP was
$13,206.4 billion and nominal GDP was $14,028.7
billion, calculate the percentage change foom 2006
b 2A07 in nominal GDP, real GDi and the price
level. What is the value of the GDP deflator in

13. 2407?
GDPbysim-
firms
a.
b.
b. The
c. The
ofanew house
of corporate
3. Exlplain transfer such as Social
compensation, are
in calculating
t true that of U.S. imports is added
exports w calculating U.S. GDP because
imports spending by Americans? E:rplain.
NominalVersus RealGDP
201 0
(The base year)
Expenditure
201 1 (Case 1)
Expenditure
201 1 (Case 2)

14. Expenditure
201 1 (Case 3)
Expenditure
COFFEE (CUPS) MILK (GALLONS) GDP (NOMINAL, REAL)
Price
s1.00
Price
51 .s0
Price
si.00
Price
$1.s0
Quantity
10
Quantity
10
Quantity
15
Quantity

15. 15
Price
s2.00
Price
54.00
Price
52.00
Price
54.00
Quantity
20
Quantity
20
Quantity
40
Quantity
4A
Economics for Managers, Third Edition, by Paul G. Farnham.

16. Published by Prentice Hall. Copyright O 2014 by Pearson
Education, lnc.
3).