Question 3

Consider the following sets of values for MPC, t, m, and recall that the multiplier is given by where Assume the aggregate supply (AS) curve is upward sloping and identical in each economy.

Economy A: MPC = 0.84, t = 0.15, m = 0.19

Economy B: MPC = 0.84, t = 0.40, m = 0.19

Economy C: MPC = 0.93, t = 0.15, m = 0.12

Economy D: MPC = 0.75, t = 0.30, m = 0.27

Economy E: MPC = 0.75, t = 0.10, m = 0.30

3.1 Calculate the magnitude of the multiplier for each economy.

3.2 Which economy would experience the largest swings in real GDP in response to a given aggregate demand (AD) shock? Which would experience the smallest swings?

3.3 Explain why the change in real GDP in response to an AD shock would not be solely determined by the multiplier for each of these economies.

3.4 Compare Economies A and B and explain how the tax-and-transfer system provides greater automatic stabilization in one of the two economies.

3.5 Explain how the slope of the AS curve would affect the short-run change in real GDP in response to an AD shock.