Question

Question 1 (500 words please) With reference to the following diagram (numbers are in billions): (a) If real GDP were initially $200, what would tend to happen to consumption expenditure and why? (b) If real GDP were initially $900, what would tend to happen to consumption expenditure and why? (c) According to Keynesian theory, if real GDP were $500 and government expenditure increased by $80, what would be the new real GDP? Expenditure (E) 1000 900 Possible equilibrium points E=Y C+I+G+NX 100 200 300 400 500 600 700 800 900 1000 GDP (Y) Question 2 On September 19, 2019, The Sydney Morning Herald reported: "Unemployment lifts to 12 month high as full-time jobs fall". Explain why, as is reported in the article, the Reserve Bank of Australia would be interested in the national unemployment rate?

Answer 1

Answer:

a) From the figure, we can infer that when GDP was $200, expenditure was $300. It means that inventory stock will be reduced in this period considering the excess demand. Now as expenditure in the economy is greater than the real output, so in the next period, producers will produce more to keep up with growing expenditure expectations carried from the last period. So, the real output will rise in the next period and the unutilized stock will reduce. b) If initially the GDP was $900 and now it has fall to around $500. This happens when there is a fall in the consumption expenditure. The consumption expenditure falls because of a fall in the income of the consumers. It may happen because of an increase in the tax rate or maybe increase in the price level. When the tax increases the consumers are left with less disposable income which leads to low consumption expenditure and thus shifts the aggregate expenditure curve downwards. This downward shift in the aggregate expenditure curve leads to a low level of GDP. Thus, less disposable income leads to low level of consumption expenditure which leads to low level of GDP.

c) As Slope of AE Curve = MPC = (800-200)/1000 = .6 So, govt expenditure Multiplier m= 1/(1-MPC) = 1/.4 = 2.5 As, m = AY/AG AY = 2.5*80 = 200 new GDP = 500+200 = $ 700 AE line shifts upwards by 80 new eqm, where new AE cuts 45° line