ECON 204 1st Edition Lecture 13Outline of Last Lecture XVIII. Long-Run Implications of Fiscal PolicyA. The budget balanceB. Measuring deficitC. Implicit liabilitiesOutline of Current LectureXIX. Exam 2 Practice ProblemsA. Consumption functionB. AD/ASC. Shock typeCurrent LectureXIX. Exam 2 Practice ProblemsA. Consumption functionProblem 1C= 1600+0.5yd1. How much of each extra dollar of disposable income will a consumer save in this economy?50 cents2. What is the value of autonomous consumer spending?1600 dollars3. If disposable income is $20,000 what is consumption?1600+0.5(20,000) = $11,600Note: the slope of the consumption function is the MPC (marginal propensity to consume)Problem 2Year Disposable Income Consumer spending 2003 100 1802004 350 3801. What is the MPC? The MPS?MPC = change in consumption/change in disp. Income(C2004 – C2003)/(yd2004 – yd2003) = (380-180)/(350-100) = 200/250MPC=0.8 & MPS=1-MPC = 0.22. What is the aggregate consumption function?These notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.C=0.8yd+a180=0.8(100)+a180-80= aa=100 C =0.8yd+100B. AD/ASProblem 11. What happens on the AD/AS model in the case of an oil price increase?Oil is a commodity – moves the SRAS curve to the left on the AD/AS modelThis shows an increase of prices and decrease of GDP on the AD/AS model2. What happens when the government applies fiscal policies to this situation?Expansionary fiscal policy (government spending increases and AD increases): the problem isthis would make prices go up. Expansionary policy to a supply shock generates inflation.Contractionary fiscal policy (government spending decreases and AD decreases): this produces unemploymentProblem 21. What happens on the AD/AS model during a recessionary gap?The AD curve shifts to the left (AD falls)2. What type of fiscal policy should the government implement in this case?Expansionary fiscal policy3. What can government do to close the recessionary gap if the multiplier is 3 and the gap consists of 500 billion dollars?Change in AD = 500 bilChange in AD = multiplier(change in government spending)500 bill = 3(change in government spending)500/3 = change in government spending = 166.66The government should spend 166.66 dollars.C. Shock typeWhat movement would you see in the AD/AS model if…1. Stock market boom increases the value of stocks held by households.Increase in AD –shift to the right (wealth goes up)2. Firms believe a recession in the future in likelyExpectation change – Decrease in AD because decrease in investment spending3. Possibility of war increases and government purchases military equipmentIncrease in AD (increase in government