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GDP, Multiplier Effect, and AS/AD Framework

1. Which of the following are included in this year's GDP? Explain your answer in each case.

a. Interest on an AT&T corporate bond.

b. Social security payments received by a retired factory worker.

c. The unpaid services of a family member in painting the family home.

d. The income of a dentist.

e. The money received by Smith when she sells her economics textbook to a book buyer.

f. The monthly allowance a college student receives from home.

g. Rent received on a two‑bedroom apartment.

h. The money received by Josh when he resells his current-year-model Honda automobile to Kim.

i. The publication of a college textbook.

j. A 2‑hour decrease in the length of the workweek.

k. The purchase of an AT&T corporate bond.

l. A $2 billion increase in business inventories.

m. The purchase of 100 shares of GM common stock.

n. The purchase of an insurance policy by Patsy Prune.

2. What is the multiplier effect? What will the multiplier be when the MPS is 0, .4, .6, and 1? What will it be when the MPC is 1, .9, .67, .5, and 0? How much of a change in GDP will result if firms increase their level of investment by $8 billion and the MPC is .80? If the MPC is .67?

3. Patsy Prune had a question on an assignment which stated the following:

"Suppose the Federal Reserve decided to reduce the interest rates or the Fed Funds rate. Demonstrate what will happen to the price level and the level of output using the AS/AD framework."

Patsy wrote the following in her answer: The AD will shift to the right causing an increase in the price and the level of output in the short-run. At the same time the AS will shift to the left because of higher prices. Output will increase and the price level increase as well in the long-run. So in the long-run both output and price will increase.

Is Patsy correct in her reasoning? Explain and be sure to use a graph to explain your answer.

Solution Preview

Please see the attached file.

1. Which of the following are included in this year's GDP? Explain your answer in each case.

a. Interest on an AT&T corporate bond. - Included. The bondholders receive interest for the money they loan to corporate, which is used by company for business.

b. Social security payments received by a retired factory worker - No. This is transfer of payment for which no service is done by the worker.

c. The unpaid services of a family member in painting the family home - No. Only market transactions are included, domestic transactions are not included. .

d. The income of a dentist - Included. He received payment for the services provided to patients.

e. The money received by Smith when she sells her economics textbook to a book buyer - No. Second hand sale is not included in GDP.

f. The monthly allowance a college student receives from home - No. Transactions between private individuals are not included, only market transactions are included.

g. Rent received on a two bedroom apartment ...

Solution Summary

The decline in interest rate is assessed.

$2.19