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

Question 1

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

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

Answer 1

Keynesian multiplier

Question 2

The size of the Keynesian multiplier depends on

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.

Answer 2

the marginal propensity to consume.

Question 3

Which of the following is true about the marginal propensity to consume and the marginal propensity to import?

A) The marginal propensity to import is typically smaller than the marginal propensity to consume because when income rises, not all goods we consume are imported.
B) The marginal propensity to import is always larger than the marginal propensity to consume because when income rises, not all goods we consume are imported.
C) The marginal propensity to import is always the same as the marginal propensity to consume because when income rises, not all goods we import are consumed.
D) The sum of the marginal propensity to import and the marginal propensity to consume is always equal to one because when income rises, we either consume or import.
E) The marginal propensity to import is sometimes larger and sometimes smaller than the marginal propensity to consume because when income rises, all goods we consume are imported.

Answer 3

The marginal propensity to import is typically smaller than the marginal propensity to consume because when income rises, not all goods we consume are imported.

Question 4

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

Question 5

The forward-looking consumption model assumes that people make consumption decisions based on

A) their mood.
B) their current income.
C) their anticipation of their future income.
D) their income taxes in the current year.
E) their perceptions of other people's behavior.

Question 6

The Keynesian multiplier measures

A) both the short-run and long-run impacts of an initial change in spending on real GDP.
B) the long-run impact of an initial change in spending on real GDP.
C) the short-run impact of an initial change in spending on real GDP.
D) the long-run impact of a change in real GDP on consumption.
E) the short-run impact of a change in real GDP on total spending.

Question 7

An increase in the marginal propensity to consume leads to an increase in the Keynesian multiplier.

Question 8

The Keynesian multiplier will be higher if

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 9

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?

Question 10

According to the forward-looking model, consumption

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 11

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.

Question 12

The formula for the Keynesian multiplier with net exports is

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

Question 13

Suppose that MPC = 0.7 and MPI = 0.2. According to the Keynesian multiplier, a decrease of $20 million in government purchases will

A) increase real GDP by $40 million.
B) decrease real GDP by $40 million.
C) increase real GDP by $100 million.
D) decrease real GDP by $100 million.
E) have no impact on real GDP.

Question 14

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

Question 15

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

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 16

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

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 17

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

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

Question 18

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

Question 19

The Keynesian multiplier is the ratio of the change in spending to a given change in real GDP.

Question 20

The formula for the Keynesian multiplier without net exports is

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

Question 21

Liquidity constraints prevent people from engaging in consumption smoothing.

Question 22

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

Question 23

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.

Question 24

Evidence from the effect of the 2008 Stimulus Act on consumption supports the permanent income hypothesis.

Question 25

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.

Question 26

The permanent income model implies that

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.

Question 27

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

Question 28

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