Consumption, Saving, Investment, and the Multiplier ❮ 103- Which of the following choices is most likely to
create the greatest decrease in real GDP?
(A) The government decreases spending, matched
with a decrease in taxes.
(B) The government increases spending with no
increase in taxes.
(C) The government decreases spending with no
change in taxes.
(D) The government holds spending constant
while increasing taxes.
(E) The government increases spending, matched
with an increase in taxes. - The tax multiplier increases in magnitude when
(A) the MPS increases.
(B) the spending multiplier falls.
(C) the MPC increases.
(D) government spending increases.
(E) taxes increase.- Which of the following is the source of the
supply of loanable funds?
(A) The stock market
(B) Investors
(C) Net exports
(D) Banks and mutual funds
(E) Savers - B—A $1 increase in DI increases consumption
by a factor of the MPC and increases saving by
a factor of the MPS. Because both MPC and
MPS represent the fraction of new income that
is consumed and saved, consumption and saving
increase by less than the increase in DI. - A—The slope of the consumption function is
the MPC. The slope of the saving function is the
MPS. - D—An increase in GDP is the result of an
increase in C, I, G, or (X – M). All other choices
represent less spending in some economic sector. - C—Look for choices that decrease GDP by the
largest magnitude. Choices B and E actually
improve the economy (and GDP), so they are
eliminated. A decrease in spending lowers GDP
by a magnitude equal to the spending multiplier,
which is larger than the tax multiplier, which in
turn is larger than the balanced budget multi-
plier. This question is a prelude to fiscal policy.- C—Knowing the relationship between the tax and
spending multipliers allows you to make the right
choice. Tm = MPC × Multiplier = MPC/MPS. - E—Banks help facilitate lending to investors, but
the real supply of those loanable funds are the
savers who choose to place some of their dispos-
able income dollars in those banks as saving.
❯ Answers and Explanations
❯ Rapid Review
Disposable income (DI): The income a consumer has left over to spend or save once he
or she has paid out net taxes. DI = Y – T.
Consumption function: A linear relationship showing how increases in disposable income
cause increases in consumption.