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Econ final ch 17

Terms in this set (23)

Suppose in a closed economy with no government, MPS = 0.25 and autonomous investment decreases by $200,
Income will decrease by $800

∆Y= 1 ×(−200)=-800
Suppose in a closed economy, MPS = 0.20, autonomous consumption increases by $100 and autonomous investment increases by $150,
A. Income will increase by $200
B. Income will increase by $1000
C. Income will increase by $500
D. Income will increase by $300
E. None of the above
(E)
Suppose in a closed economy, C = 100 + 0.75Y and I = 200, the equilibrium level of income is,
A. $1,750
B. $1,500
C. $1,150
D. $1,250
E. None of the above

(E)
Suppose in a closed economy, C = 300 + 0.50Y and I = 100. The multiplier is
2
Suppose in a closed economy, C = 300 + 0.50Y and I = 100. If investment increases by $400, the equilibrium level of income will increase by
$800
Suppose in a closed economy, C = 300 + 0.50Y and I = 100. If investment increases by $400 and autonomous consumption decreases by 200, the equilibrium level of income will change by
+$400
Suppose in a closed economy, C = 100 + 0.90Y and I = 200. If autonomous consumption increases by $200, the equilibrium level of income will increase from_____ to _____
E. $3,000, 5,000
Suppose in a closed economy, C = 200 + 0.8Y and I = 150. If autonomous consumption increases by $100, the equilibrium level of income will increase by_____ and the multiplier is _____
$500, 5
When a small open economy is in equilibrium,
S+M=I+X
In a small open economy, given X - M = 100
S-I=100
In a small open economy, given S = 200 and I = 150
Trade balance is in surplus
The multiplier in a closed economy is
Larger than the multiplier in a small open economy
In what way is the elasticity approach (as studied in the previous chapter) different from the income-multiplier approach (as studied in this chapter)? What are the assumptions of these two models?
The elasticity approach is the classical adjustment mechanism to BOP disequilibria where a BOP deficit/surplus is corrected through automatic changes in relative prices caused by a change in exchange rate, while the income-multiplier approach is the Keynesian approach to BOP adjustments where a BOP deficit/surplus is corrected through automatic changes in income.
Assume that the national income in an open small economy is at equilibrium. According to the Keynesian approach, does this imply that the trade balance is also at equilibrium? Explain.
Not necessarily. The trade balance is in equilibrium when X = M. The national income is in equilibrium when S - I = X - M. This does not necessarily imply X = M.
How does the automatic income adjustment mechanism operate to remove a deficit/surplus from the trade balance in the Keynesian approach? Explain.
Starting from equilibrium in trade balance, suppose there is an autonomous increase in imports. This causes a deficit in the trade balance. The increase in imports leads to a reduction in national income (i.e., Y↓) as imports replace domestic production. The reduction in national income (Y) would cause a reduction in induced imports (imports induced by a reduction in income), causing a reduction in trade balance deficits.
What is the main theme of the absorption approach?
A trade balance deficit will improve if (Y/A)↑.
Whether currency devaluation improves a TB deficit depends on the state of the economy. If there is unemployment, currency devaluation will improve a TB deficit given that the Marshall-Lerner condition is satisfied. If the economy is at full-employment, to improve a TB deficit the government must reduce absorption. This can be done through contractionary fiscal and monetary policies. Market forces would also reduce absorption automatically.
How is BOP deficit eliminated under the absorption approach, assuming full employment?
Some adjustments take place automatically through market forces. These are as follows: (1) currency devaluation redistributes income from wage earners to investors, (2) currency devaluation results in inflation. This would push people into higher tax brackets which in turn reduce absorption (spending), (3) the rise in domestic prices, resulting from currency devaluation, would reduce real money balances. To increase real money balances to the desired level, people reduce their absorption (spending).
What is meant by foreign repercussions? Why is the foreign trade multiplier for a large open economy smaller than that for a small open economy?
Foreign repercussions involve two large trade partners (Nation 1 and Nation 2) where a change in Nation 1's export affects Nation 2. Subsequent changes in Nation 2 will also affect Nation 1's export in the next period. These two-way changes would cause the initial change in export to reduce in size in the subsequent periods.
Given that C = 200 + 0.75Y, M = 100 + 0.25Y, I = 300, X = 500.

Determine the equilibrium income algebraically. Draw the S-I and X-M graph and show the equilibrium on the graph.
S = -200 + 0.25Y
S - I = -200 + 0.25Y - 300 = -500 + 0.25Y X - M = 500 - 100 - 0.25Y = +400 - 0.25Y S-I=X-M
-500 + 0.25Y = +400 - 0.25Y
Ye = 1800
Given that C = 200 + 0.75Y, M = 100 + 0.25Y, I = 300, X = 500.

Is the trade balance in equilibrium? If not, determine the size of the deficit or surplus.
M = 100 + 0.25(1,800) = 550
So the trade balance is:
X - M = 500 - 550 = -50
*Deficit
Given that C = 200 + 0.75Y, M = 100 + 0.25Y, I = 300, X = 500.

At what level of income would the trade balance be in equilibrium?
X=M
500 = 100 + 0.25Y ⇒ Y = 1,600
So if the income level were 1,600, the trade balance would have been in equilibrium.
Given that C = 200 + 0.75Y, M = 100 + 0.25Y, I = 300, X = 500.

Starting from an equilibrium level of income obtained in part a, determine algebraically and show graphically the effect of an autonomous increase in I of 100 and M of 200 on the equilibrium level of income and on X-M. Make sure to show the size of the deficit or surplus on your graph.
S = -200 + 0.25Y, I′ = I + 100 = 300 + 100 = 400 M′ = M + 200 = (100 + 0.25Y) + 200 = 300 + 0.25Y
S - I′ = -200 + 0.25Y - 400 = -600 + 0.25Y X - M′ = 500 - 300 - 0.25Y = +200 - 0.25Y S - I′ = X - M′
-600 + 0.25Y = +200 - 0.25Y
Ye = 1,600
M′ = 300 + 0.25 (1600) = 700
TB = X - M′ = 500 - 700 = -200
How does the automatic monetary adjustment reduce a BOP surplus, assuming a fixed exchange rate system?
Under a fixed exchange rate system a BOP surplus ⇒ MB↑ ⇒ Ms ↑ (through a multiplier effect) ⇒ i↓ ⇒ I↑⇒Y↑⇒ M↑⇒ Trade balance deteriorates. Further, a surplus in the BOP would cause P↑ ⇒ X↓ and M↑. Also when i↓⇒ Capital outflows ↑ ⇒ BOP↓ further.
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