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The income-expenditure diagram

 

Aggregate

 

expenditure

 


 

450 line

 

C+Ip = AE

 


 

A

 


 

C

 

C, consumption

 


 

B

 


 

Planned investment , Ip

 


 

GDP1

 


 

GDP2

 


 

GDP3

 


 

The above represents a 2 sector economy with only households and firms, so Y = C + I

 

1. If the economy produces at GDP 3 then what does the distance ?C? measure?

 

Distance ?C? means real GDP exceed spending. Unsold goods accumulate. It causes firms to cut production until the amount

 

they produce equals AE.

 

People save more and spend less. Company?s inventories start rising and they need cut productions.

 

2. What can you say about the value of savings and investment at GDP2?

 

Savings = Planned investment (leakages = planned injections.)

 

3. What is the autonomous variable in this case?

 

Planned Investment.

 

4. What does the slope of the consumption function measure?

 

The slope of the consumption function equals the MPC.

 

MPC is the fraction of the additional income that is spent.

 

MPC=the change in consumption divided by the change in income.

 

5. If the MPC in this case were 0.75, what would the simple Keynesian multiplier be?

 

1/(1-0.75)=4

 

6. How much extra autonomous demand would take the economy from GDP 2 to GDP 3?

 

(Expressed as an algebraic distance on the graph)

 

B

 

7. The fact that planned investment is shown as a horizontal line means that in this case investment

 

spending is induced or autonomous? Underline which one.

 

Autonomous

 

8. What does the distance ?A? measure?

 

Distance ?A? means Spending exceeds the amount produced. Company wants to produce more toward

 

equilibrium point.

 


 

 


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