Monday 26 October 1998
For questions 1 through 3, for the event listed on its own, in a Keynesian framework indicate whether the effect would be to
(a) increase, (b) decrease, or
(c) leave unchanged,
equilibrium output and employment:
Other things equal, if US households plan to save more, they plan to consume less. Therefore planned consumption expenditure decreases, so aggregate expenditure decreases. The equilibrium level of output and employment will decrease. The actual change in equilibrium output and employment will be greater than the initial planned decrease in consumption, because of multiplier effects. The mechanism would be that when households save more and plan less, business sells less than expected (planned); inventories therefore increase, so planned production is reduced. This reduces output and income, leading to a further decrease in consumption and thereby the multiplier effects.
2. Starting from a position of excess capacity and unemployment, government spending is increased.
Government spending [purchases] is part of Aggregate Expenditure, Y = C + I +G + (X - M), so increased government spending increases aggregate expenditure, which increases equilibrium output and income (by more than the initial increase in government purchases because of multiplier effects).
3. An increase in income tax rates.
If income tax rates go up, taxes paid go up, i.e. net taxes increase, household disposable income is reduced, so consumption expenditure is reduced, output and income are decreased [by more than the initial increase in taxes (times the marginal propensity to consume) because of multiplier effects].