MCQs

[mgh]

Hi, I'm struggling with a couple of MCQs - if anyone is able to explain them it'd be very much appreciated!

1) In an open economy with no taxation, the marginal propensity to save is 0.25 and the
level of income is €800m. What is the likely level of consumption expenditure
resulting from a rise in government expenditure of €100 million? (Answer is C - my thoughts are the multiplier = 1/0.25 so increase in Y due to increase in G is 400, Y = C + S => Y = C + 0.25S => 1200 = C + 0.25*1200 which results in C = 900 just not sure if that's the correct way)
A €700 million
B €800 million
C €900 million
D €1000 million

2) If planned injections are less than planned withdrawals: ( Answer is B - I thought if planned injections are less than withdrawals then exports will be less than imports so the balance of trade would worsen)
A unemployment will fall.
B the balance of trade will tend to improve.
C inflation will tend to rise.
D national income will rise.

3)5,000 bottles of a soft drink are demanded when the price for each bottle is £5. When
the price is £6 only 4000 bottles are demanded. The marginal revenue from
increasing the price is: (Answer is C - I thought it would be 6*4000-5*5000 = -1000)
A +£1,000.
B -£1,000.
C +£1.
D -£1.

Thanks in advance

 

[Dave Johnson]

Hi - I'll answer these one by one.

The first question is (I think) September 2012 q14.

We are told this is an open economy (i.e. there is international trade) but we are given no info on it, so we end up having to assume that there is no international trade.

• The multiplier then becomes 1/mps = 4
• Then Y increases by 4 x 100 = 400 to 1200
• normally we would write C = a + bY where a is autonomous consumption and b is the marginal propensity to consume
• We aren't told anything about autonomous consumption, so we assume C = bY = mpc x Y
• thus the new value of C is 0.75 x Y = 0.75 x 1200 = 900

So you got there (I think), but the question isn't worded helpfully, so you're right to question the logic.

Dave

 

[Dave Johnson]

The second question is (I think) April 2015 q18.

This is another tricky question. To solve it we need to think about the 45-degree diagram.

Total expenditure is Cd + J, and is usually drawn as a straight line with gradient <45 degrees and a positive intercept.

When J decreases, this moves the line downwards, moving the equilibrium Y=AD position (i.e. the intercept with the 45-degree line) to the left. This is a reduction in Y, i.e. a contraction of the economy. This excludes option D straight away.

A contraction represents an increase in unemployment so we can exclude option A. In addition demand pull inflation pressures will reduce, so we can also exclude option C.

Option B is the correct answer because a contraction of the economy will reduce the demand for imports, improving the balance of trade. We usually assume demand for exports is independent of domestic GDP, and so are unaffected.

 

[Dave Johnson]

The third question is (I think) September 2010 q23.

It's another funny one because usually we think of marginal revenue in terms of the effect of a change in quantity rather than price, but as long as we use the correct formula we will get the right answer.

MR = change in total revenue/change in quantity
= (6*4000 - 5*5000)/(4000 - 5000)
= -1000/-1000
= 1

 

[mgh]

Thank you very much for your responses! All makes good sense. Just to check for the first question did you derive the mpc through backsolving from the multiplier i.e. 1/mps = 4 = 1/(1-mpc) so mpc = 0.75, or is there some kind of shortcut where we can say mpc = 1-mps

 

[Dave Johnson]

Here I'm using the formula Y = T + C + S, but noting that in this case T = 0, so when we differentiate with respect to Y we get 1 = mpc + mps.

EDIT: or if you prefer, in an economy without taxes, all income is either spent (consumed) or saved.

 

[mgh]

Thanks again