1. In our simple model, if C = 100 + 0.8y, and I = 50, equilibrium output will be ______.

2. If in Exercise 3.1 I increase to 100,

a. The equilibrium income will be ______.

b. The multiplier is ______.

3. If the marginal propensity to save is 0.3, the MPC must be ______.

4. If the MPC decreases, the multipliers will ______.

5. Estimating Changes in Aggregate Demand.

a. Suppose C = Ca + 0.6y and that a shock decreases Ca by $10 billion. By how much will equilibrium income decrease?

b. An economy has an MPC of 0.6. By how much will a $10 billion increase in government purchases increase equilibrium income? By how much will a $10 billion increase in taxes decrease equilibrium income?

6. The Paradox of Thrift. The United States has instituted many policies to attempt to increase savings rates in the United States. One such policy was the creation of individual retirement accounts and other incentives for savings. An implication of the income expenditure model is that an increase in the desire of consumers to save will not necessarily lead to higher savings. In fact, total savings will either remain the same or perhaps fall. This is known as the paradox of thrift. Let s see why this is true with an example.

a. Suppose I equals 40 and the savings function is S = 100 + 0.4y. Equilibrium income, y, in the economy is 350. Now suppose consumers wish to increase their savings; the new savings function becomes S = 80 + 0.4y. Calculate the new level of equilibrium output and savings after the change in the savings function.

b. Explain why equilibrium savings are unchanged.

c. Now suppose that with a decline in equilibrium income, investment also falls. What would be the effect on equilibrium output and total savings if households now wished to increase their desired savings?

d. What does this suggest about the ability of policymakers to increase aggregate savings by affecting citizens savings rates?

7. Solving a Simple Model. Consider an economy in which C = 200 + 0.5y and I = 200.

a. Determine the equilibrium income algebraically.

b. What is the multiplier for investment spending for this economy?

c. What is the savings function?

d. Draw the savings function on a graph with the investment level and indicate how equilibrium income is determined.

e. What is the level of saving at the level of equilibrium income? Show it is equal to investment.

8. Earthquakes and Subsequent GDP Growth. Massive earthquakes, such as the one that afflicted Sichuan province in China in 2008 are terrible events. Yet, economists believe that GDP typically rises after an earthquake. Explain why this happens and whether that means that earthquakes are really good things.

9. A Difficulty in Estimating Government Spending Multipliers. Tax revenues typically rise along with GDP. Governments may typically spend some of this additional revenue on discretionary items in the budget. Assuming this is true, how does this complicate the work of analysts trying to determine the multiplier effects of discretionary spending on GDP?