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13. Assuming that an economy’s aggregate demand is given by its domestic consumption C and investment I, AD = C + I = c0 + c1Y + I. In the economy’s goods market equilibrium, this equals its outpu
13. Assuming that an economy’s aggregate demand is given by its domestic consumption C and investment I, AD = C + I = c0 + c1Y + I. In the economy’s goods market equilibrium, this equals its output: AD = Y. Solving for Y this yields:
Y = [1/(1 -c1 )] (c0+ I)
Given this equation, which of the following statements is correct?
- The multiplier is given by 1 – c1.
- The boost in the economy’s output is the same, regardless of whether the aggregate demand shock comes from an increase in investment I or in autonomous consumption c0.
- The larger the marginal propensity to consume (c1), the smaller the multiplier.
- If c1 = 1/3, then a £1 million increase in investment would result in a £2 million increase in output.
14. In the US and the UK, loans are widely available based on a rise in home equity. Additionally, unlike in France and Germany where large down-payments (as a percentage of the house price) are required, in the US and the UK only small down-payments are required for house purchases. On the basis of this information, which of the following statements is correct for the US and the UK when there is a rise in housing prices?
- There is a positive financial accelerator effect for the existing homeowners who are credit-constrained.
- There would be no effect on the consumption of the existing homeowners who are not credit-constrained.
- Would-be homeowners would increase saving and reduce their consumption more than they would in France and Germany.
- A rise in housing prices is likely to dampen consumption in the US and the UK.
15. Which of the following statements regarding fiscal policy is correct?
- Expansionary fiscal policy (e.g. increasing the government deficit or reducing the surplus) always has a stabilising effect on the economy.
- Unemployment benefits and taxes automatically increase government spending and cut taxation in a downturn, while they trim spending and raise taxes in a boom. These are therefore automatic stabilisers.
- In a recession, the aim of a government fiscal expansion is to over-ride the effects of automatic stabilisers.
As a family worried about mounting debts should cut spending and save more, so should an economy adopt austerity measures when its debt level is high, to restore its public finances to balance