Econ 1250 In class A6 – Ch 13 Q1. Suppose that the marginal propensity to consume is 0.9. If government spending increases by $30 billion, what will be the total effect on real GDP? Q2. Suppose that the marginal propensity to consume is 0.9. If transfer payments increase by $30 billion, what will be the total effect on real GDP? Q3. Suppose that the marginal propensity to consume is 0.9. If there is a recessionary gap of 120 billion, calculate the change in Taxes required to close the output gap.
In economics, the marginal propensity to consume (MPC) is described as the aggregate increase in households’ spending on the consumption of goods and services following an aggregate increase in income. Arguably, when households receive a raise in income, they may spend the extra money on consumption rather than on savings, and this additional spending denotes their MPC. In this case scenario, the marginal propensity to consume is 0.9, which implies that the households gained an extra, presumably $10, leading to an MPC of 0.9.
In the same context, government spending increases by $30 billion, which creates an injection of new demand in the economy’s income flow. Notably, as the government injects $30 billion in the economy, it creates an upward multiplier effect whereby the final consumer income is raised significantly. This change in income may have a considerable impact on the real GDP because an open economy experiences a circular flow of income. As the government injects the $30 billion in the economy, the consumer income also increases, leading to a rise in the household’s MPC. However, it is also worth noting that while consumers spend, others generate income from the spending. Therefore, an increased government spending of $30 billion is likely to raise the real GDP, as household increased spending is, in turn, used in the production of goods and services in the economy.
Question Two
In the second case scenario, an increase in transfer payments by $30 billion would cause a withdrawal of income from the economy. This change in income would create a potential downward multiplier effect in the economy, and households would prefer to save more and spend less. As noted, an open economy has a circular flow of income. Therefore, as individuals save more and spend less on consumption, less money is also injected into investment and production. The result of this income withdrawal would be a decline in the real GDP.
Question Three
In economics, a recessionary gap describes a scenario where a country’s GDP is lower than expected in full employment. In this scenario, the selected economy’s recessionary gap is 120 billion, while the marginal propensity to consume is 0.9. The changes in taxes required to close the output gap can be calculated by multiplying the recessionary gap by the multiplier. However, the multiplier must first be derived from the provided variables to help obtain the required taxes.
Step 1: Calculate the multiplier
The formula for calculating the multiplier is 1/1-MPC (1/1-0.9). Therefore, the economy’s multiplier is 10.
Step 2: Calculate the taxes
The required taxes can be calculated by multiplying the multiplier by the recessionary gap. Therefore, the taxes needed to close the output gap is $1200 billion (10*120billion).
Part 2
Question One
Consumer surplus is a measurement of consumers’ additional benefit for paying less for a commodity they were willing to pay a higher price for. Often, the majority of the items from which consumers enjoy a surplus have a less elastic demand. Notably, low elasticity means that such goods’ demand does not change significantly following a change in their prices. This aspect explains why consumers may be willing to purchase the same quantity of the commodity regardless of the price changes.
Besides being theoretical, consumer surplus can be empirically observed from the current events in the United States and globally. For example, households in the country are currently enjoying a consumer surplus from the high supply of pears. Notably, it is the fall season, and the harvest and supply of pears is higher than the summer and winter season. Due to the fruits’ increased supply, sellers are willing to charge less for the commodity to ensure the products’ fast movement. As a result, buyers in the country are getting more consumer surplus from this commodity’s purchase.
Another example of a commodity from which buyers enjoyed a consumer surplus during the pandemic is oil. Notably, when the COVID-19 pandemic hit, the global oil prices declined sharply, costing less than consumers would be willing to pay in normal circumstances. This price decline meant that the buyers could derive more benefits from the purchase than the price they would be paying for the commodity.
Similarly, buyers have enjoyed a consumer surplus from the purchase of apparel during the COVID-19 pandemic. Industry experts reveal that in February 2020, prices in the apparel industry had increased significantly. However, when the pandemic struck, the commodities’ prices reduced as sellers made efforts to boost winter clothes’ sale to make room for fall clothing. A decline in the commodity price in the phase of a pandemic and a transition in seasons triggered a consumer surplus.
Question Two
Over the past few months, the demand for some goods and services have changed due to the ongoing pandemic. Notably, this demand has mainly been triggered by internal and external factors that drive demand, such as income and consumer expectations. For example, the demand for salon-related services has significantly changed since the onset of the pandemic. Before, the demand for salon-related services was on the rise as individuals preferred having their hair done by professionals in the industry than at home. However, this service’s demand dropped sharply after the pandemic hit the globe due to lockdown, which forced most consumers to prefer doing their hair at home. In this scenario, the determinant of demand change was the change in consumer preference.
Economists can observe a similar pattern from the price of essential consumer goods during the pandemic. Notably, the demand for consumer goods such as food products, toiletries, and other home products was at equilibrium before the pandemic. Stores and other sale outlets were also charging relatively stable prices for the commodities. However, when the pandemic hit the globe, the demand for consumer goods spiked, and some stores began charging higher prices for basic commodities. The commodity price change was likely triggered by a shortage of supply of some of the commodities. However, the increase in the demand for basic commodities was mainly determined by consumer expectations. Arguably, consumers anticipated that there would be a shortage in the supply of the goods due to the imposed lockdown, which led them to demand more commodities.
Besides basic commodities, the demand for personal protective equipment (PPE) also changed significantly after the onset of the pandemic. Before the pandemic, the demand for PPEs such as face shields, glass eye coverings, boots, and full-length gown was relatively low as rare scenarios required their use. When the pandemic hit the globe, the demand for PPEs rose due to the materials’ vitalness when attending to patients. The primary determinant of the demand change was consumers need to protect themselves against the virus.
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