Self-Check Questions


In the Keynesian framework, which of the following events might cause a recession? Which might cause inflation? Sketch AD/AS diagrams to illustrate your answers.

  1. a large increase in the price of the homes people own
  2. rapid growth in the economy of a major trading partner
  3. the development of a major new technology that offers profitable opportunities for business
  4. an increase in interest rates
  5. a significant price decrease in a good imported from a major trading partner

In a Keynesian framework, using an AD/AS diagram, which of the following government policy choices offer a possible solution to recession? Which offer a possible solution to inflation?

  1. a tax increase on consumer income
  2. a surge in military spending
  3. a reduction in taxes for businesses that increase investment
  4. a major increase in what the U.S. government spends on healthcare

Use the AD/AS model to explain how an inflationary gap occurs, beginning from the initial equilibrium in Figure 11.6.


Suppose the U.S. Congress cuts federal government spending to balance the federal budget. Use the AD/AS model to analyze the likely impact on output and employment. Hint—Revisit Figure 11.6.


Sketch the aggregate expenditure-output diagram with a recessionary gap.


Sketch the aggregate expenditure-output diagram with an inflationary gap.


An economy has the following characteristics

Y = National income

Taxes = T = 0.25Y

C = Consumption = 400 + 0.85(Y – T)

I = 300

G = 200

X = 500

M = 0.1(Y – T).

Find the equilibrium for this economy. If potential GDP is $3,500, then what change in government spending is needed to achieve this level? Do this problem two ways. First, plug $3,500 into the equations and solve for G. Second, calculate the multiplier and derive the answer that way.


Table 11.8 represents the data behind a Keynesian cross diagram. Assume the tax rate is 0.4 of national income, the MPC out of the after-tax income is 0.8, investment is $2,000, government spending is $1,000, exports are $2,000, and imports are 0.05 of after-tax income. What is the equilibrium level of output for this economy?

National Income After-Tax Income Consumption I + G + X Minus Imports Aggregate Expenditures
$8,000 $4,340
Table 11.8 Data Table for Question 8

Explain how the multiplier works. Use an MPC of 80 percent in an example.


How would a decrease in energy prices affect the Phillips curve?


Does Keynesian economics require the government to set controls on prices, wages, or interest rates?


List three practical problems with the Keynesian perspective.