W H AT I S E C O N O M I C S ?

191

1 EXPENDITURE
MULTIPLIERS**

1
Answers to the Review Quizzes
Page 269 (page 677 in Economics)
1. Which components of aggregate expenditure are influenced by real GDP?
Consumption expenditure and imports are influenced by real GDP. Both increase
when real GDP increases.
2. Define and explain how we calculate the marginal propensity to consume and
the marginal propensity to save.
The marginal propensity to consume is the proportion of an increase in disposable
income that is consumed. In terms of a formula, the marginal propensity to
consume, or MPC, can be calculated as C/YD, where means change in. The
marginal propensity to save is the proportion of an increase in disposable income
that is saved. In terms of a formula, the marginal propensity to save, or MPS, can
be calculated as S/YD.
3. How do we calculate the effects of real GDP on consumption expenditure and
imports by using the marginal propensity to consume and the marginal
propensity to import?
The effects of real GDP on consumption expenditure and imports are determined
respectively by the marginal propensity to consume and the marginal propensity
to import. In particular, the effect of a change in real GDP on consumption
expenditure equals the marginal propensity to consume multiplied by the change
in disposable income. Similarly, the effect of a change in real GDP on imports
equals the marginal propensity to import multiplied by the change in real GDP.

Page 273 (page 681 in Economics)

1. What is the relationship between aggregate planned expenditure and real GDP
at equilibrium expenditure?
Equilibrium expenditure occurs when aggregate planned expenditure equals real
GDP.
2. How does equilibrium expenditure come about? What adjusts to achieve
equilibrium?
Equilibrium expenditure results from adjustments in real GDP. For instance, if
aggregate planned expenditure exceeds real GDP, firms find that their inventories
are below their targets. In response, firms increase production to meet their
inventory targets, As production increases, real GDP increases. The increase in real
GDP increases aggregate planned expenditure but by less than the increase in real

191
192

GDP. Eventually real GDP increases sufficiently so that it equals aggregate planned
expenditure and, at that point, equilibrium expenditure occurs.
3. If real GDP and aggregate expenditure are less than equilibrium expenditure,
what happens to firms inventories? How do firms change their production?
And what happens to real GDP?
If real GDP and aggregate expenditure are less than their equilibrium levels, an
unplanned decrease in inventories occurs. The unplanned decrease in inventories
leads firms to increase production to restore inventories to their planned levels.
The increase in production increases real GDP.
4. If real GDP and aggregate expenditure are greater than equilibrium
expenditure, what happens to firms inventories? How do firms change their
production? And what happens to real GDP?
If real GDP and aggregate expenditure are greater than their equilibrium levels, an
unplanned increase in inventories occurs. The unplanned increase in inventories
leads firms to decrease production to restore inventories to their planned levels.
The decrease in production decreases real GDP.
Page 278 (page 686 in Economics)
1. What is the multiplier? What does it determine? Why does it matter?
The multiplier is the amount by which a change in autonomous expenditure is
multiplied to determine the change in equilibrium expenditure and real GDP. A
change in autonomous expenditure changes real GDP by an amount determined
by the multiplier. The multiplier matters because it tells us how much a change in
autonomous expenditure changes equilibrium expenditure and real GDP.
2. How do the marginal propensity to consume, the marginal propensity to
import, and the income tax rate influence the multiplier?
The marginal propensity to consume, the marginal propensity to import, and the
income tax rate all influence the magnitude of the multiplier. The multiplier is
smaller when the marginal propensity to consume is smaller, when the marginal
propensity to import is larger, and when the income tax rate is larger.
3. How do fluctuations in autonomous expenditure influence real GDP?
Fluctuations in autonomous expenditure bring business cycle turning points. When
autonomous expenditure changes, the economy moves from one phase of the
business cycle to the next. For example, if autonomous expenditure decreases,
equilibrium expenditure and real GDP decrease and, as a result, the economy
enters the recession phase of the business cycle.

Page 283 (page 691 in Economics)

1. How does a change in the price level influence the AE curve and the AD curve?
A change in the price level shifts the AE curve and creates a movement along the
AD curve.
2. If autonomous expenditure increases with no change in the price level, what
happens to the AE curve and the AD curve? Which curve shifts by an amount
that is determined by the multiplier and why?
A change in autonomous expenditure with no change in the price level shifts both
the AE curve and the AD curve. The AE curve shifts by an amount equal to the
change in autonomous expenditure. The multiplier determines the magnitude of
the shift in the AD curve. The AD curve shifts by an amount equal to the change in
autonomous expenditure multiplied by the multiplier.

192
 W H AT I S E C O N O M I C S ? 193

3. How does an increase in autonomous expenditure change real GDP in the

short run? Does real GDP change by the same amount as the change in
aggregate demand? Why or why not?
In the short run, an increase in aggregate expenditure increases real GDP.
However, the increase in real GDP is less than the increase in aggregate demand
because the price level rises. The more the price level rises (the steeper the SAS
curve) the smaller the increase in real GDP.
4. How does real GDP change in the long run when autonomous expenditure
increases? Does real GDP change by the same amount as the change in
aggregate demand? Why or why not?
In the long run, an increase in aggregate expenditure has no effect on real GDP,
that is, real GDP does not change. The change in real GDPzerois less than the
change in aggregate demand. The change in real GDP is nil because, in the long
run, the economy returns to its full-employment equilibrium. In the long run, an
increase in aggregate expenditure raises the price level but has no effect on real
GDP.

Page 289 (page 697 in Economics)

In an economy, autonomous consumption expenditure is $50 billion, investment is
$200 billion, and government expenditure is $250 billion. The marginal propensity
to consume is 0.7 and net taxes are $250 billion. Exports are $500 billion and
imports are $450 billion. Assume that net taxes and imports are autonomous and
the price level is fixed.
a. What is the consumption function?
The consumption function is the relationship between consumption expenditure
and disposable income, other things remaining the same. In this case the
consumption function is C = 50 + 0.7(Y 250) where the 50 is $50 billion and
the 250 is $250 billion.
b. What is the equation of the AE curve?
The equation of the AE curve is AE = 375 + 0.7Y, where Y is real GDP and the 375
is $375 billion. Aggregate planned expenditure is the sum of consumption
expenditure, investment, government purchases, and net exports. Using the
symbol AE for aggregate planned expenditure, aggregate planned expenditure is
AE = 50 + 0.7(Y 250) + 200 +250+ 50
AE = 50 + 0.7Y 175 + 200 + 250 + 50
AE = 375 + 0.7Y
c. Calculate equilibrium expenditure.
Equilibrium expenditure is $1,250 billion. Equilibrium expenditure is the level of
aggregate expenditure that occurs when aggregate planned expenditure equals
real GDP. That is, AE = 375 + 0.7Y and AE = Y. Solving these two equations for Y
gives equilibrium expenditure of $1,250 billion.
d. Calculate the multiplier.
The multiplier equals 1/(1 the slope of the AE curve). The equation of the AE curve
tells us that the slope of the AE curve is 0.7. So the multiplier is 1/(1 0.7), which is
3.333.
e. If investment decreases to $150 billion, what is the change in equilibrium
expenditure?
Equilibrium real expenditure decreases by $166.67 billion. From part d the
multiplier is 3.333. The change in equilibrium expenditure equals the change in
investment, $50 billion, multiplied by 3.333.

193
194

f. Describe the process in part (e) that moves the economy to its new
equilibrium expenditure.
When investment decreases by $50 billion, aggregate planned expenditure is less
than real GDP. Firms find that their inventories are accumulating above target
levels. As a result, they decrease production to reduce inventories. Real GDP
decreases. The decrease in real GDP decreases disposable income so that
consumption expenditure falls. In turn, the decrease in consumption expenditure
leads to a further decrease in aggregate planned expenditure. Real GDP still
exceeds aggregate planned expenditure though by less than was initially the case.
Nonetheless unwanted inventories are still accumulating and firms continue to cut
production, further reducing real GDP. This process continues until eventually real
GDP will decrease enough to equal aggregate planned expenditure.

194
Answers to the Study Plan Problems and
Applications
1. In an economy, when income increases from $400 billion to $500 billion,
consumption expenditure changes from $420 billion to $500 billion. Calculate
the marginal propensity to consume, the change in saving, and the marginal
propensity to save.
The marginal propensity to consume is the fraction of a change in disposable
income that is consumed. In this economy, when income increases by $100 billion
per year, consumption expenditure increases by $80 billion per year. The marginal
propensity to consume equals $80 billion $100 billion, or 0.8.
Saving equals disposable income minus consumption expenditure. Therefore from
the $100 billion increase in income, consumption expenditure increased by $80
billion, leaving a $20 billion increase in saving. The marginal propensity to save is
the fraction of a change in disposable income that is saved. In this economy, for
the increase in income of $100 billion, saving increases by $20 billion, so the
marginal propensity to save is $20 billion $100 billion, which is 0.2.
Use Figure 11.1 to work Problems 2 and 3.
Figure 11.1 illustrates the components of
aggregate planned expenditure on Turtle
Island. Turtle Island has no imports or exports,
no incomes taxes, and the price level is fixed.
2. Calculate autonomous expenditure and
the marginal propensity to consume.
Autonomous expenditure is $2 billion.
Autonomous expenditure is expenditure
that does not depend on real GDP.
Autonomous expenditure equals the
value of aggregate planned expenditure
when real GDP is zero.
The marginal propensity to consume is
0.6. When the country has no imports or
exports and no income taxes, the slope of
the AE curve equals the marginal
propensity to consume. When income
increases from zero to $6 billion, aggregate planned expenditure increases from
$2 billion to $5.6 billion. That is, when real GDP increases by $6 billion, aggregate
planned expenditure increases by $3.6 billion. The marginal propensity to
consume is $3.6 billion $6 billion, which is 0.6.
3. a. What is aggregate planned expenditure when real GDP is $6 billion?
Figure 11.1 shows that aggregate planned expenditure is $5.6 billion when real
GDP is $6 billion.
b. If real GDP is $4 billion, what is happening to inventories?
Firms inventories are decreasing. When real GDP is $4 billion, aggregate planned
expenditure exceeds real GDP, so firms sell all that they produce and more. As a
result, inventories decrease.
c. If real GDP is $6 billion, what is happening to inventories?
Firms are accumulating inventories. That is, unplanned inventory investment is
positive. When real GDP is $6 billion, aggregate planned expenditure is less than
real GDP. Firms cannot sell all that they produce and inventories pile up.
 E X P E N D I T U R E M U LT I P L I E R S 141

4. Explain the difference between induced consumption expenditure and

autonomous consumption expenditure. Why isnt all consumption expenditure
induced expenditure?
Induced consumption expenditure is consumption expenditure that changes when
disposable income changes. Autonomous consumption expenditure is
consumption expenditure that would occur in the short run even if disposable
income was zero. Not all consumption expenditure is induced consumption
expenditure because, in the short run, even if someone has no income they still
will have some (autonomous) consumption expenditure, if for nothing else, for
food.
5. Explain how an increase in business investment at a constant price level
changes equilibrium expenditure.
Investment is a component of autonomous aggregate expenditure. An increase in
investment increases aggregate expenditure so the AE curve shifts upward.
Equilibrium expenditure increases.
Use the following data to work Problems 6 and 7.
An economy has a fixed price level, no imports, and no income taxes. MPC is 0.80,
and real GDP is $150 billion. Businesses increase investment by $5 billion.
6. Calculate the multiplier and the change in real GDP.
With no imports and no income taxes, the multiplier equals 1/(1 MPC). So the
multiplier is 1/(1 0.8), which is 5.0 Then the $5 billion increase in investment
increases real GDP by 5.0 $5 billion, which is $25 billion.
7. Calculate the new real GDP and explain why real GDP increases by more than
$5 billion.
Real GDP was initially $150 billion. The increase in investment increased real GDP
by $25 billion, so real GDP increases to $175 billion. Real GDP increases by more
than the initial increase in investment because the increase in investment
increases disposable income which induces additional increases in consumption
expenditure. So real GDP increases both because investment increases and also
because of induced increases in consumption expenditure.
8. An economy has a fixed price level, no imports, and no income taxes. An
increase in autonomous expenditure of $2 trillion increases equilibrium
expenditure by $8 trillion. Calculate the multiplier and explain what happens
to the multiplier if an income tax is introduced.
The multiplier is defined as the change in equilibrium expenditure divided by the
change in autonomous expenditure. In this problem the multiplier equals $8 trillion
$2 trillion which is 4.0.
If an income tax is introduced, the multiplier decreases in value. With an income
tax, at each spending round less disposable income is created leading to smaller
increases in induced expenditure.
Use the following data to work Problems 9 to 13.
Suppose that the economy is at full employment, the price level is 100, and the
multiplier is 2. Investment increases by $100 billion.
9. What is the change in equilibrium expenditure if the price level remains at
100?
The initial change in equilibrium expenditure is $200. The initial effect of the
increase in investment increases equilibrium expenditure by the change in
investment times the multiplier. The multiplier is 2 and the change in investment
is $100 billion, so the initial change in equilibrium expenditure is $200 billion.

2016 Pearson Education, Inc.

142 CHAPTER 11

10.a. What is the immediate change in the quantity of real GDP demanded?
The quantity of real GDP demanded increases by $200 billion. The increase in
investment shifts the aggregate demand curve rightward by the change in
investment times the multiplier. The multiplier is 2 and the change in investment
is $100 billion, so the aggregate demand curve shifts rightward by $200 billion.
b. In the short run, does real GDP increase by more than, less than, or the same
amount as the immediate change in the quantity of real GDP demanded?
In the short run, real GDP increases by less than $200 billion. Real GDP is
determined at the intersection of the AD curve and the SAS curve. In the short run,
the price level will rise and real GDP will increase but by an amount less than the
shift of the AD curve.
11. In the short run, does the price level remain at 100? Explain why or why not.
In the short run, the price level rises. Real GDP is determined at the intersection of
the AD curve and the SAS curve. In the short run, the increase in aggregate
demand means that the price level will rise as the economy moves along its
upward-sloping SAS curve.
12.a. In the long run, does real GDP increase by more than, less than, or the same
amount as the immediate increase in the quantity of real GDP demanded?
In the long run, real GDP equals potential GDP, so real GDP does not increase. Real
GDP is determined at the intersection of the AD curve and the SAS curve. After the
initial increase in investment, money wages increase, the SAS curve shifts
leftward, and in the long run, real GDP moves back to potential GDP.
b. Explain how the price level changes in the long run.
Real GDP is determined at the intersection of the AD curve and the SAS curve. In
the long run, money wages increase so the SAS curve shifts leftward, raising the
price level by more than it rose in the short run.
13. Are the values of the multipliers in the short run and the long run larger or
smaller than 2?
The multiplier in the short run is less than the multiplier of 2 because the short-run
increase in real GDP is less than $200 billion. The long-run multiplier is even
smaller. It equals zero.
14. Use the data in the Worked Problem on p. 287 (page 699 in Economics).
Calculate the change in equilibrium expenditure when investment decreases
by $150 billion.
The multiplier equals 4. Consequently the change in equilibrium expenditure
equals (4) ($150 billion), or a decrease of $600 billion.

2016 Pearson Education, Inc.

 E X P E N D I T U R E M U LT I P L I E R S 143

Answers to Additional Problems and Applications

Use the following data to work Problems 15 and 16.
You are given the information in the table about the Disposable
economy of Australia. income Saving
(billions of dollars per
15. Calculate the marginal propensity to save.
year)
The marginal propensity to save is the fraction of
a change in disposable income that is saved. In 0 0
Australia, when disposable income increases by 100 25
$100 billion per year, saving increases by $25 200 50
billion per year. The marginal propensity to save is 300 75
$25 billion $100 billion, which is 0.25. 400 100

16. Calculate consumption at each level of disposable income. Calculate the

marginal propensity to consume.
The table to the right shows Australias
consumption expenditure schedule. Consumption Disposable Consumptio
expenditure equals disposable income minus income n
saving. For each increase in disposable income of expenditure
$100 billion, consumption expenditure increases (billions of dollars per
by $75 billion. The marginal propensity to year)
consume is 0.75. The marginal propensity to 0 0
consume plus the marginal propensity to save 100 75
equals 1. Because the marginal propensity to save 200 150
equals 0.25, the marginal propensity to consume 300 225
equals 0.75. 400 300

Use the following news clip to work Problems 17 to 19.

Americans $2.4 trillion Poorer
The Federal Reserve reported that household wealth decreased by $2.4 trillion or
$21,000 per household in the third quarter of 2011. This drop is the steepest since
2008 and the second consecutive quarterly drop. Foreclosures lowered household
debt slightly but credit card debt increased. Many households are struggling to buy
the essentials and spending on food has decreased. Separately, the Bureau of
Economic Analysis reported that consumption expenditure increased by $39 billion
in the third quarter of 2011.
Sources: The New American, December 11, 2011 and the Bureau of Economic
Analysis

2016 Pearson Education, Inc.

144 CHAPTER 11

17. Explain and draw a graph to illustrate how a fall in household wealth would be
expected to influence the consumption function and saving function.

Figure 11.2a shows the effect of a decrease in wealth on the consumption function
and Figure 11.2b shows the effect on the saving function. Consumption
expenditure decreases so the consumption function shifts downward from CF0 to
CF1 while saving increases so the saving function shifts upward from SF0 to SF1.
18. What factors might explain the actual changes in consumption expenditure
and wealth that occurred in the third quarter of 2011?
According to the article, consumption increased. At least two other factors could
explain the discrepancy between the predicted decrease in consumption in part
a and the increase that actually occurred. First, disposable income might have
increased. This change would lead to a movement upward along the (downward-
shifted) consumption function so that consumption expenditure increased.
Alternatively peoples expected future incomes might have risen. The upward
revision in expected future income would lead to an upward shift of the
consumption function which would offset the fall from the decrease in wealth.
19. Draw a graph of a consumption function and show at what points consumers
were actually operating in the second and third quarters. Make any necessary
assumptions and explain your answer.
Regardless of any increase in future expected income, it is likely the case that the
decrease in wealth led to a net downward shift of the consumption function
because the decrease in wealth was so large. In Figure 11.2a the consumption
function shifts downward from CF0 to CF1. Equally likely, however, disposable
income increased. So the economy moves from disposable income of $10.5 trillion
and consuming at point A on consumption function CF0 to disposable income of
$11.0 trillion and consuming at point B on consumption function CF1.

2016 Pearson Education, Inc.

 E X P E N D I T U R E M U LT I P L I E R S 145

A B C D E F G
1 Y C I G X M
2 A 100 110 50 60 60 15
3 B 200 170 50 60 60 30
4 C 300 230 50 60 60 45
5 D 400 290 50 60 60 60
6 E 500 350 50 60 60 75
7 F 600 410 50 60 60 90
Use the spreadsheet above, which lists real GDP (Y ) and the components of
aggregate planned expenditure in billions of dollars, to work Problems 20 and 21.
20. Calculate autonomous expenditure. Calculate the marginal propensity to
consume.
Autonomous expenditure equals the value of aggregate planned expenditure when
real GDP is zero. Because the spreadsheet does not list GDP of zero, we must
extrapolate to calculate the value of consumption expenditure and imports when
GDP equals zero. From the spreadsheet, consumption expenditure falls by $60
billion for every $100 billion decrease in GDP. So when GDP equals zero,
autonomous consumption expenditure is $50 billion. Similarly, from the
spreadsheet, imports decrease by $15 billion for every $100 billion decrease in
GDP. So when GDP equals zero, imports equal zero. Autonomous expenditure is
$50 billion (consumption expenditure) plus $50 billion (investment) plus $60
billion (government expenditure) plus $60 billion (exports), which equals $220
billion.
The marginal propensity to consume is 0.6. When income increases from $100
billion to $200 billion, consumption expenditure increases from $110 billion to
$170 billion. A $100 billion increase in GDP increases consumption expenditure by
$60 billion. So the marginal propensity to consume is $60 billion $100 billion,
which is 0.6.

2016 Pearson Education, Inc.

146 CHAPTER 11

21.a. What is aggregate planned expenditure when real GDP is $200 billion?
Aggregate planned expenditure is $310 billion. Aggregate planned expenditure is
the sum of consumption expenditure ($170 billion) plus planned investment ($50
billion) plus government expenditure ($60 billion) plus exports ($60 billion) minus
imports ($30 billion), which is $310 billion.
b. If real GDP is $200 billion, explain the process that moves the economy
toward equilibrium expenditure.
Inventories are decreasing so that the unplanned inventory change is negative.
When real GDP is $200 billion, aggregate planned expenditure is $310 billion.
Because aggregate planned expenditure exceeds real GDP, firms sell all that they
produce and even more so that inventories are decreasing. Firms then increase
their production, to restore their inventories, and real GDP increases.
c. If real GDP is $500 billion, explain the process that moves the economy
toward equilibrium expenditure.
Firms are accumulating inventories so that the unplanned inventory change is
positive. When real GDP is $500 billion, aggregate planned expenditure is $445
billion. Firms cannot sell all that they produce so that unplanned inventories
increase. Firms respond by decreasing their production, to lower their inventories,
and real GDP decreases.
22. Wholesale Inventories Decline, Sales Rise
The Commerce Department reported that wholesale inventories fell 1.3
percent in August for a record 12th consecutive month, evidence that
companies are trimming orders to factories, which helped depress economic
output during the recession. Economists hope that the rising sales will
encourage businesses to begin restocking their inventories, which would boost
factory production and help bolster broad economic growth in coming months.
Source: The New York Times, October 8, 2009
Explain why a fall in inventories is associated with recession and a restocking
of inventories might bolster economic growth.
Inventories are part of investment. If the fall in inventories reflects a fall in planned
inventories, then planned investment decreases which decreases aggregate
expenditure and real GDP. If the restocking of inventories is a planned restocking,
then planned investment increases, which boosts aggregate expenditure and real
GDP.
23. Obamas New Stimulus
The Obama recovery plan announced on Monday includes proposed spending
of $50 billion to rebuild 150,000 miles of roads, construct and maintain 4,000
miles of rail, and fix or rebuild 150 miles of runways.
Source: USA Today, September 10, 2010
If the slope of the AE curve is 0.7, calculate the immediate change in
aggregate planned expenditure and the change in real GDP in the short run if
the price level remains unchanged.
The increase in government expenditure will have a multiplier effect on aggregate
expenditure and real GDP. The multiplier equals 1/(1 the slope of the AE curve).
The slope of the AE curve is 0.7 so the multiplier is 1/(1 0.7), which is 3.3. With
this multiplier, the $50 billion increase in government expenditure increases
aggregate expenditure by 3.3 $50 billion, or $165 billion. In the short run, when
the price level is constant, real GDP increases by the same amount, $165 billion.

2016 Pearson Education, Inc.

 E X P E N D I T U R E M U LT I P L I E R S 147

24. Obamas Economic Recovery Plan

President Obama's proposal to jolt a listless recovery with $180 billion worth of
tax breaks and transportation projects left economists largely unimpressed
Tuesday.
Source: USA Today, September 10, 2010
If taxes fall by $90 billion and the spending on transport projects increases by
$90 billion, which component of Obamas recovery plan would have the larger
effect on equilibrium expenditure, other things remaining the same?
The spending on transportation projects will have the larger effect because the
expenditure multiplier is larger than the tax multiplier. The expenditure multiplier
is larger because in the first round all of the increased government expenditure
increases aggregate expenditure whereas part of a tax cut is saved and hence
does not increase aggregate expenditure.

Use the following news item to work Problems

25 to 27.
The BEA reported that in the third quarter of
2014 U.S. exports increased by $40 billion.
25. Explain and draw a graph to illustrate the
effect of an increase in exports on
equilibrium expenditure in the short run.
The increase in exports increases
aggregate expenditure because exports is
a component of aggregate expenditure.
As shown in Figure 11.3, the aggregate
expenditure curve shifts upward from AE0
to AE1. Because aggregate expenditure
has increased, real GDP increases, In
Figure 11.3 the increase in aggregate
expenditure increases real GDP from
$15.8 trillion to $16.0 trillion.

6. Explain and draw a graph to illustrate the effect

of an increase in exports on equilibrium real
GDP in the short run.
The increase in exports increases
aggregate expenditure and creates an
increase in the aggregate demanded.
Figure 11.4 illustrates the effect on real
GDP. The aggregate demand curve shifts
rightward, from AD0 to AD1. The price level
rises and equilibrium real GDP increases
from $15.8 trillion to $15.9 trillion. The
economy is in an above full-employment
equilibrium.

2016 Pearson Education, Inc.

148 CHAPTER 11

2016 Pearson Education, Inc.

 E X P E N D I T U R E M U LT I P L I E R S 149

27. Explain and draw a graph to illustrate

the effect of an increase in exports on
equilibrium real GDP in the long run.
In the short run, the economy is in an
above full-employment equilibrium. As
time passes, the money wage rate rises,
which decreases short-run aggregate
supply and shifts the short-run
aggregate supply curve leftward.
Eventually the short-run aggregate
supply decreases enough so that the
economy returns to full employment. In
Figure 11.5, this analysis means that the
short-run aggregate supply curve
eventually shifts from SAS 0 to SAS 1 and
the economy returns to full employment,
with real GDP of $15.8 trillion and a
price level of 122.

28. Compare the multiplier in the short run and the long run and explain why they
are not identical.
The long-run multiplier is zero, which means that the short-run multiplier is larger
than the long-run multiplier. The long-run multiplier equals zero because in the
long run the economy returns to full employment. For example, in the short run an
increase in aggregate demand increases real GDP, which means that the short-run
multiplier is positive. But the economy is at a greater than full-employment
equilibrium. Therefore the money wage rate starts to rise. The rise in the money
wage rate decreases short-run aggregate supply and thereby decreases real GDP.
The short-run aggregate supply continues to decrease until the economy reaches
full employment, at which point it stops decreasing. But the ultimate change in
real GDP is zero, which means the long-run multiplier is zero.
Use the following news clip to work Problems 29 to 31.
Consumer Sentiment in U.S. Rose to Three Month High
Consumer sentiment was up in August helped by merchant discounts, especially
from auto dealerships who received incentives from automakers Honda, General
Motors, and Toyota to lower prices.
But consumers are worried about the future. They are worried about tax changes
and government budget cuts that are on the horizon. Capital spending fell
somewhat.
Source: Bloomberg, September 1, 2012
29. Which of the expenditures listed in the news clip are part of induced
expenditure and which is part of autonomous expenditure?
Induced consumption expenditure changes with changes in disposable income.
Autonomous consumption expenditure does not change when disposable income
changes. For many consumers, purchasing new cars increase when their incomes
rise. For these consumers, these items are induced expenditure. Other Americans
plan to buy automobiles regardless of the change in their income perhaps because
their consumer sentiment is up, or perhaps because prices of cars have fallen.

2016 Pearson Education, Inc.

150 CHAPTER 11

For these consumers, these expenditures are autonomous. Capital spending is part
of autonomous expenditure.

2016 Pearson Education, Inc.

 E X P E N D I T U R E M U LT I P L I E R S 151

30. Which of the events reported in the news

clip would change aggregate demand and
which would change the quantity of real
GDP demanded? Provide a graphical
illustration of the distinction.
The increase in consumption expenditure
induced by increased income, the
autonomous increase in consumption, and
the increase in capital spending all
increase aggregate demand and shift the
aggregate demand curve rightward. The
increase in consumption expenditure that
results from lower prices reflects a change
in consumption from a lower price level
and creates a change in the quantity of
real GDP demanded. Figure 11.6
illustrates these differences. The change
from point A to point B reflects a change
in aggregate demand. The movement
from point B to point C reflects a change in the quantity of real GDP demanded.

31. Explain and draw a graph to illustrate how increasing consumer confidence
influences aggregate expenditure and aggregate demand.

Increasing consumer confidence increases autonomous consumption. It increases

aggregate expenditure and aggregate demand. As illustrated in Figure 11.7a, the
aggregate expenditure curve shifts upward, from AE0 to AE 1 and in Figure 11.7b
the aggregate demand curve shifts rightward, from AD0 to AD1.

2016 Pearson Education, Inc.

152 CHAPTER 11

32. Japan Slides Into Recession

In Japan, consumer prices slid at a faster pace in July and industrial production
unexpectedly slumped.
Source: Bloomberg, September 1, 2012
Contrast what the news clip says is happening in Japan with what is happening
in the United States in Problem 29 and provide a graphical analysis of the
differences.

The news clip suggests that in Japan aggregate demand is decreasing so that both
the price level and real GDP are decreasing. Figure 11.8a shows this situation. The
information in Problem 29 suggests that consumption expenditure is increasing
and, while investment (capital spending) is decreasing. However it seems that the
change in consumption expenditure exceeds the change in investment so U.S.
aggregate demand is increasing. Figure 11.8b shows this situation.

2016 Pearson Education, Inc.

 E X P E N D I T U R E M U LT I P L I E R S 153

Economics in the News

33. After you have studied Economics in the News on pp. 284285 (692693 in
Economics), answer the following questions.
a. If the 2014 changes in inventories were mainly planned changes, what role
did they play in shifting the AE curve and changing equilibrium expenditure?
Use a two-part figure (similar to that on p. 272 (p. 680 in Economics)) to
answer this question.

Figure 11.9a shows aggregate planned expenditure; Figure 11.9b shows unplanned
inventory change. When aggregate planned expenditure is given by AE0,
unplanned inventory change is equal to zero when real GDP is $16.0 trillion, so
unplanned inventory change is given by the top line in Figure 11.9b. If the change
in inventories was planned, then planned investment increased and with it
aggregate planned expenditure also increased. The increase in aggregate planned
expenditure shifts the aggregate expenditure curve upward, as illustrated by the
shift from AE0 to AE1 in Figure 11.9a. It shifts the unplanned inventory change line
downward to the lower curve, Unplanned inventory change 1, in Figure 11.9b. The
increase in aggregate expenditure increases equilibrium real GDP. In figure 11.9a,
real GDP increases from $16.0 trillion to $16.1 trillion. In Figure 11.9b, at real GDP
of $16.1 trillion, along the new unplanned inventory change curve line, unplanned
inventory change is zero.
b. The BEA news release reports that exports of goods and services were up
10.1 percent and imports of goods and services were up 11.0 percent. Were
these increases in expenditure increases in autonomous expenditure or
increases in induced expenditure, and how do they influence the magnitude
of the multiplier?
Changes in exports are autonomous expenditure and changes in imports are
induced expenditure. Changes in exports have no effect on the magnitude of the
multiplier. Changes in imports do affect the size of the multiplier. The larger the
quantity of imports that are induced by a change in income, the smaller the
multiplier.

2016 Pearson Education, Inc.

154 CHAPTER 11

c. Using the assumptions made in Figure 2 on p. 285 (p. 693 in Economics),

what is the value of the autonomous expenditure multiplier?
The autonomous expenditure multiplier equals 1/(1 slope of AE line). In the
figure, the slope along the top red line is equal to ($15.99 trillion $15.91 trillion)/
($15.99 trillion $15.83 trillion) = ($0.08 trillion)/(($0.16 trillion) = 0.5. So the
autonomous expenditure multiplier equals 1/(1 0.5) = 2.0.
34. In an economy with a fixed price level, autonomous spending is $20 trillion
and the slope of the AE curve is 0.6.
a. What is the equation of the AE curve?
The equation of the AE curve is AE = 20 + 0.6Y, where Y is real GDP and the 20 is
$20 trillion.
b. Calculate equilibrium expenditure.
Equilibrium expenditure is $50 trillion. Equilibrium expenditure is the level of
aggregate expenditure that occurs when aggregate planned expenditure equals
real GDP. That is, AE = 20 + 0.6Y and AE = Y. Solving these two equations for Y
gives equilibrium expenditure of $50 trillion.
c. Calculate the multiplier.
The multiplier equals 1/(1 the slope of the AE curve). The equation of the AE curve
tells us that the slope of the AE curve is 0.6. So the multiplier is 1/(1 0.6), which is
2.5.
d. Calculate the shift of the aggregate demand curve if investment increases by
$1 billion.
The shift of the aggregate demand curve equals the multiplier multiplied by the
change in investment, or 2.5 $1 billion, which is $2.5 billion.

2016 Pearson Education, Inc.