Question

Explain why each of the following are true, false, or uncertain. Use diagrams where appropriate. It is the explanation that is important.

5. When aggregate consumption is $100 (billion) while disposable income is $120 (billion), the marginal propensity to save from disposable income must be 20%.

6. Ceteris paribus, an increase in the domestic price level increases the price of domestic goods increases their price relative to foreign goods resulting in a downward shift of aggregate expenditures and a leftward shift of the aggregate demand curve.

7. In an economy with a mix of price-taking and price-setting firms, the short-run aggregate supply curve will be horizontal.

8. If the government reduces tax rates, the aggregate expenditure function shifts up.

Answer 1

5) without knowing autonomous consumption,it is impossible to know marginal propensity to save or consume.

For example

C=a+mpc*yd

Let a=4

100=4+mpc*120

Mpc=96/120=0.8

Mps=1-mpc=1-0.8=0.2=20%

Let a=16

Mpc=84/120=0.7

Mps=1-0.7=0.3=30%

So statement is wrong.

6)

When price level Increases from p1 to p0, there is movement along aggregate demand curve.

Aggregate expenditure curve will shift because it is function of income ,so decrease in exports leads to downward shifts to aggregate expenditure curve but aggregate DEMAND curve is a function of price ,there will be a upward movement along aggregate demand curve.

So statement is wrong.

7) the horizontal aggregate supply curve ,shows on aggregate level the cost of production is constant means st current price firms can supply whatever amount they want.the constant cost reflect sticky wages .so it has nothing to do with price taking or setting firms.

8) reduction in tax leads to increase in disposable income and at same national income consumption Increases and aggregate expenditure function shifts up , showing more aggregate expenditure at same income level.

Statement is correct