Chapter Eleven: Quiz Answers -- The Output Multiplier

1. Given an MPC of 0.75, the value of the simple output multiplier is
   4. 1/(1 - 0.75) = 4.

2. The intuitive reason that the multiplier works is that
   initial changes in Aggregate Demand lead to more output, which gives consumers more income, a portion of which they spend, thus increasing output and income even more. The key to understanding the multiplier is income-induced consumption.

3. The value of the output multiplier with an MPC of 0.75 and proportional taxes of 0.20 (20%) is
   2.5. 1/(1 - 0.75(1 - 0.2)) = 1/(1 - 0.75 * 0.8) = 1/(1 - 0.6) = 2.5.

4. The value of the output multiplier with an MPC of 0.75 and an MPI of 0.05 is
   3.33. 1/(1 - 0.75 + 0.05) = 1/0.30 = 3.33.

5. The value of the output multiplier with an MPC of 0.8, assuming there is a vertical AS curve is
   0. If the Aggregate Demand curve shifts to the right but the Aggregate Supply curve is vertical, output doesn't change at all. The only thing that changes is the price level.

6. Suppose that the MPC is 0.8 and there are no proportional taxes. If you want to decrease equilibrium output by $500, then you must change autonomous Aggregate Demand by
   -100. Recall that
   change in Y = (output multiplier) x (initial change in AD), or
   -500 = 5 x (initial change in AD), therefore
   initial change in AD = -500/5 = -100.

7. Which of the following projects is likely to lead to the largest permanent increase in equilibrium output?
   a new Community College is built with government funds. A community college is a permanent government expenditure that is funded year after year. The other examples of government expenditures are temporary.

8. Multiplier effects dampen out over time because
   only a portion of increased disposable income is injected back into the economy. In other words, the MPC is less than one. What would the multiplier be if the MPC were one?

9. The value of the output multiplier shrinks as proportional taxes rise.
   True. If consumers have less disposable income after each "round" of the multiplier, the income-induced consumption is smaller so the output multiplier is smaller.

10. A one-time increase in autonomous Aggregate Demand will not lead to any change in equilibrium output once all the multiplier effects have worked through. But a permanent increase in Aggregate Demand permanently increases the equilibrium level of output.
    True. Temporary increases in autonomous Aggregate Demand temporarily boost income in the economy but the effects eventually fade away. Permanent increases in autonomous Aggregate Demand, however, permanently increase equilibrium output.