Question 1

The permanent income model implies that

Accepted Answer

A)  a permanent tax cut has a larger effect on consumption than does a temporary tax cut. 
B)  a permanent tax cut has a smaller effect on consumption than does a temporary tax cut. 
C)  tax cuts should not be used because consumers are not rational. 
D)  both permanent and temporary tax cuts are effective in changing consumption. 
E)  both permanent and temporary tax cuts have no effects on consumption. 
A)  a permanent tax cut has a larger effect on consumption than does a temporary tax cut. 
B)  a permanent tax cut has a smaller effect on consumption than does a temporary tax cut. 
C)  tax cuts should not be used because consumers are not rational. 
D)  both permanent and temporary tax cuts are effective in changing consumption. 
E)  both permanent and temporary tax cuts have no effects on consumption. A

Question 2

If the expenditure line is steeper, the Keynesian multiplier will be larger.

Accepted Answer

A) True 
 B)False  True

Question 3

Sketch the 45-degree line and the expenditure line on a diagram. Use this diagram to show what happens to the level of income if government purchases decline. Does income decrease by more or by less than the downward shift in government purchases? Explain.

Accepted Answer

As shown in the diagram below, a decline in government purchases causes the aggregate expenditure line to shift down in a parallel way to E₁ from E₀. Notice that the resulting change in the point of spending balance or income is larger than the change in government purchases. The change in income is greater than the change in spending because consumption is sensitive to changes in income, and there will be a multiplier effect.

Question 4

In 2008, the government under the Bush administration implemented a tax cut in the form of a one-time tax rebate. That tax cut had only a small impact on personal consumption expenditure and real GDP. Explain.

Accepted Answer

Because the tax cut was good for only on

Question 5

The Keynesian multiplier will be higher if

Accepted Answer

A)  the marginal propensity to consume is larger. 
B)  the marginal propensity to import is larger. 
C)  real GDP is higher. 
D)  the expenditure line is higher. 
E)  the liquidity constraint is greater. 
A)  the marginal propensity to consume is larger. 
B)  the marginal propensity to import is larger. 
C)  real GDP is higher. 
D)  the expenditure line is higher. 
E)  the liquidity constraint is greater.

Question 6

According to the permanent income model, the marginal propensity to consume is larger in the case of a permanent change in income than a temporary change in income.

Accepted Answer

A) True 
 B)False

Question 7

The Keynesian multiplier relies on the assumption that people are forward looking.

Accepted Answer

A) True 
 B)False

Question 8

The formula for the Keynesian multiplier without net exports is

Accepted Answer

A)     . 
B)    . 
C)    . 
D)    . 
E)    . 
A)     . 
B)    . 
C)    . 
D)    . 
E)    .

Question 9

The forward-looking model implies that the Keynesian multiplier is greater for a temporary tax cut than a permanent tax cut.

Accepted Answer

A) True 
 B)False

Question 10

All else being equal, a higher propensity to import leads to a larger Keynesian multiplier.

Accepted Answer

A) True 
 B)False

Question 11

The rational expectations assumption implies that anticipated tax changes have no impact on consumption at all.

Accepted Answer

A) True 
 B)False

Question 12

The spending multiplier is the ratio of the change in real GDP to

Accepted Answer

A)  a shift in the expenditure line. 
B)  a movement along the expenditure line. 
C)  a shift in the 45-degree line. 
D)  a change in marginal propensity to consume. 
E)  a change in potential GDP. 
A)  a shift in the expenditure line. 
B)  a movement along the expenditure line. 
C)  a shift in the 45-degree line. 
D)  a change in marginal propensity to consume. 
E)  a change in potential GDP.

Question 13

Which of the following measures the change of real GDP in the short run as a result of a an increase in government purchases?

Accepted Answer

A)  Spending balance 
B)  Potential GDP 
C)  Life-cycle model 
D)  Keynesian multiplier 
E)  45-degree line 
A)  Spending balance 
B)  Potential GDP 
C)  Life-cycle model 
D)  Keynesian multiplier 
E)  45-degree line

Question 14

The forward-looking model predicts that the marginal propensity to consume is constant over time.

Accepted Answer

A) True 
 B)False

Question 15

Suppose that MPC = 0.8 and MPI = 0. According to the Keynesian multiplier, an increase of $20 million in government purchases will

Accepted Answer

A)  increase real GDP by $16 million. 
B)  decrease real GDP by $16 million. 
C)  increase real GDP by $100 million. 
D)  decrease real GDP by $100 million. 
E)  have no impact on real GDP. 
A)  increase real GDP by $16 million. 
B)  decrease real GDP by $16 million. 
C)  increase real GDP by $100 million. 
D)  decrease real GDP by $100 million. 
E)  have no impact on real GDP.

Question 16

Suppose in 2010, real GDP was $160 trillion. Suppose further that the marginal propensity to consume was 0.75 and the marginal propensity to import was 0.25. Using the Keynesian multiplier, how much should government purchases be changed if policymakers attempt to raise real GDP to $180 trillion by changing government purchases?

Accepted Answer

The expected change in real GD

Question 17

The formula for the Keynesian multiplier with net exports is

Accepted Answer

A)    . 
B)    . 
C)    . 
D)    . 
E)    . 
A)    . 
B)    . 
C)    . 
D)    . 
E)    .

Question 18

The size of the Keynesian multiplier depends on

Accepted Answer

A)  the location of the expenditure line. 
B)  the level of spending. 
C)  the level of income. 
D)  the location of the 45-degree line. 
E)  the marginal propensity to consume. 
A)  the location of the expenditure line. 
B)  the level of spending. 
C)  the level of income. 
D)  the location of the 45-degree line. 
E)  the marginal propensity to consume.

Question 19

According to the forward-looking model, consumption

Accepted Answer

A)  reacts mostly to a permanent change in income. 
B)  reacts mostly to a temporary change in income. 
C)  reacts equally to permanent or temporary changes in income. 
D)  is always subject to a liquidity constraint. 
E)  does not react to either temporary or permanent changes in income. 
A)  reacts mostly to a permanent change in income. 
B)  reacts mostly to a temporary change in income. 
C)  reacts equally to permanent or temporary changes in income. 
D)  is always subject to a liquidity constraint. 
E)  does not react to either temporary or permanent changes in income.

Question 20

The permanent income model implies the same relationship between changes in consumption and income as

Accepted Answer

A)  the backward-looking model. 
B)  the life-cycle model. 
C)  the liquidity constraint model. 
D)  the Keynesian multiplier. 
E)  None of these 
A)  the backward-looking model. 
B)  the life-cycle model. 
C)  the liquidity constraint model. 
D)  the Keynesian multiplier. 
E)  None of these

Exam 22: Deriving the Formula for the Keynesian Multiplier and the Forward-Looking Consumption Model

The permanent income model implies that

If the expenditure line is steeper, the Keynesian multiplier will be larger.

Sketch the 45-degree line and the expenditure line on a diagram. Use this diagram to show what happens to the level of income if government purchases decline. Does income decrease by more or by less than the downward shift in government purchases? Explain.

In 2008, the government under the Bush administration implemented a tax cut in the form of a one-time tax rebate. That tax cut had only a small impact on personal consumption expenditure and real GDP. Explain.

The Keynesian multiplier will be higher if

According to the permanent income model, the marginal propensity to consume is larger in the case of a permanent change in income than a temporary change in income.

The Keynesian multiplier relies on the assumption that people are forward looking.

The formula for the Keynesian multiplier without net exports is

The forward-looking model implies that the Keynesian multiplier is greater for a temporary tax cut than a permanent tax cut.

All else being equal, a higher propensity to import leads to a larger Keynesian multiplier.

The rational expectations assumption implies that anticipated tax changes have no impact on consumption at all.

The spending multiplier is the ratio of the change in real GDP to

Which of the following measures the change of real GDP in the short run as a result of a an increase in government purchases?

The forward-looking model predicts that the marginal propensity to consume is constant over time.

Suppose that MPC = 0.8 and MPI = 0. According to the Keynesian multiplier, an increase of $20 million in government purchases will

The formula for the Keynesian multiplier with net exports is

The size of the Keynesian multiplier depends on

According to the forward-looking model, consumption

The permanent income model implies the same relationship between changes in consumption and income as

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