Tutorial 2

1. Calculate GDP using the following information ( where there is no government and
no foreign trade and C= consumption, I=investment, and Y=GDP) C=100+0.8Y,
I=1000
Y=100+0.8Y+1000
Y-0.8Y=1100
0.2Y=1100
Y=5500
2. How will the answer to Question 1 change if I increases to, a)2000, b)4000 and
c)10,000
a) Y=100+0.8Y+2000
Y-0.8Y=2100
0.2Y=2100
Y=10500
b) Y= 100+0.8Y+4000
Y-0.8Y=4100
0.2Y=4100
Y=4100/0.2
Y=20500
c) Y=100+0.8Y+10000
Y-0.8Y=10100
0.2Y=10100
Y= 50500
3. GNP =2000,C=1700 ,G=50 and NX =40.
a) What is investment (I)
GNP=C+I+G+NX
2000=1700+I+50+40
2000=1790+ I
I= 2000-1790
I=210
b) If exports are 350, what are imports?
NX=40
NX=(X-M)
40= 350-M
M=310
c) If depreciation is 130, what is National income?
Net National Product= Gross National Income- Depreciation
=2000-300
=1700
National income= Net National Product- statistical discrepancy

d) In this example net exports are positive. Could they be negative?

Net exports can be negative, if the import expenditure is greater than the export
income.
4. How is the size of the multiplier related to
a)the marginal propensity to imports ( MPI)
b)the marginal propensity to consume
The Multiplier is the ratio of a change in the equilibrium real income due to the
autonomous change that brought it about.
It is defined as 1 divided by the marginal propensity to withdraw(MPI+MPT+MPS).
If the MPI increases the multiplier would reduce. If MPC increases then the MPS
would reduce and the multiplier would increase( MPC+MPS=1).
5. Why does the trade balance deteriorate as the domestic income increases? Explain
with the aid of a diagram.
Exports depend on spending decisions made by foreign consumers or overseas firms
that purchase foreign goods and services.
Imports depend on spending decisions of domestic residents. Thus imports rise when
the other categories of spending rise. Because consumption rises when the income of
domestic households rise, the imports of foreign produced consumption goods also
rises with the rise in domestic income.
The desired net exports are negatively related to GDP because of the positive
relationship between desired imports and GDP.
(The Net export function diagram is available in the PowerPoint Lesson 3)

6.
a). If there is an initial injection of demand of say 400m and

The marginal propensity to save = 0.2

The marginal rate of tax on income = 0.2

The marginal propensity to import goods and services is 0.3

Calculate the value of the national income multiplier= 1/0.2+0.2+0.3= 1.43

Since the initial change of demand is 400m, what would be the final rise in GDP?
400 x 1.43= 571.42
b).

The marginal propensity to save = 0.1

The marginal rate of tax on income = 0.2

The marginal propensity to import goods and services is 0.2

Find the value of the multiplier and the final rise in GDP
Multiplier=1/0.1+0.2+0.2= 2
Final rise in GDP= 400 x 2= 800.

In class Exercises.
A. Which of the following is least likely to result in an increase in potential GDP?
1. An advance in technology
2. An increase in the money wage rate

3. An increase in the quantity of capital

Solution: Answer 2- Potential GDP will not change in response to an increase in
the money wage rate.
B. All else equal, aggregate demand is most likely to decrease in response to a
decrease in:
1. Interest rates
2. Federal tax revenues
3. Expected corporate profits
Solution: Answer 3. Aggregate demand is expected to decrease if corporate
profits decrease because firms will have less money to spend on investment in
capital equipment.
C. Assuming the economy is operating at full employment , what is the most
likely long-run effect of an increase in government spending on the price level
and real GDP
1. The price level and real GDP will both increase
2. The price level will increase , but there will be no change in real GDP
3. The price level will not change, but there will be an increase in the real
GDP.
Solution: Answer 2. If an economy is operating at full employment, the longrun
effect of an increase in government spending is to increase the price level while
real GDP will be unchanged at the full employment level.