University of the Philippines

SCHOOL OF ECONOMICS

Economics 100.1
1st Semester, AY 2021-2022
QUIZ #3

Prof. MS Gochoco-Bautista J. Abong/L. Garces/P. Benedicto

MULTIPLE CHOICE
Instructions: Choose the letter of the best to each question.

1. Which component of aggregate demand is likely to be the most volatile?

A. Consumption
B. Investment
C. Government expenditures
D. Net exports

2. Which of the following events might result in a downward shift of the investment demand curve?

A. Improvements in total production in the economy

B. Investment tax credits given to businesses
C. New technological inventions
D. Heightened political conflicts in the country

3. When the economy goes into a recession, real GDP _____ and unemployment _____.

A. rises, rises
B. rises, falls
C. falls, rises
D. falls, falls

4. If the government wants to contract aggregate demand, it can _____ government purchases or
_____ taxes.

A. decrease, increase
B. decrease, decrease
C. increase, decrease
D. increase, increase

5. Which of the following statements is true about the expenditure multiplier in a closed economy
with government where consumers save a part of their disposable income?

A. The expenditure multiplier is always between 0 and 1.

B. The expenditure multiplier can vary from 0 to a number greater than 1.
C. The expenditure multiplier is always greater than 1.
D. The expenditure multiplier is always less than the tax multiplier.

6. The multiplier effect of changes in government spending is calculated:

1 𝑀𝑃𝐶
A. C.
𝑀𝑃𝐶 1−𝑀𝑃𝐶
𝟏 𝑀𝑃𝐶
B. D. −
𝟏−𝑴𝑷𝑪 𝑀𝑃𝑆
 University of the Philippines
SCHOOL OF ECONOMICS

Economics 100.1
1st Semester, AY 2021-2022
QUIZ #3

Prof. MS Gochoco-Bautista J. Abong/L. Garces/P. Benedicto

7. With the economy in recession because of inadequate aggregate demand, the Philippine
government increases its purchases by ₱ 1.2 billion. Suppose the central bank adjusts the money
supply to keep the interest rate constant, investment spending is fixed, and the marginal propensity
to consume is 2⁄3. How large is the anticipated increase in aggregate demand?

A. ₱ 400 million
B. ₱ 800 million
C. ₱ 1.8 billion
D. ₱ 3.6 billion

8. On the basis of the Keynesian model of output determination, the MPC in the diagram above is:

1 1
A. C.
2 4
4 𝟐
B. D.
5 𝟑
 University of the Philippines
SCHOOL OF ECONOMICS

Economics 100.1
1st Semester, AY 2021-2022
QUIZ #3

Prof. MS Gochoco-Bautista J. Abong/L. Garces/P. Benedicto

9. Based on the figure below, which of the following is true why 𝑌1 is not the equilibrium income?

A. Intended investment is greater than savings.

B. Intended investment is less than savings.
C. Intended investment is equal to savings.
D. Income is greater than aggregate demand.

10. Ignoring the signs, what is the relationship between the expenditure multiplier and the lump-sum
tax multiplier?

A. The expenditure multiplier is equal to the lump-sum tax multiplier.

B. The expenditure multiplier is greater than the lump-sum tax multiplier.
C. The expenditure multiplier is less than the lump-sum tax multiplier.
D. The expenditure multiplier is twice the lump-sum tax multiplier.

11. The following variables make up the right-hand side of the equation for the current account balance
except:

A. Imports
B. Savings
C. Investment
D. Government revenues
 University of the Philippines
SCHOOL OF ECONOMICS

Economics 100.1
1st Semester, AY 2021-2022
QUIZ #3

Prof. MS Gochoco-Bautista J. Abong/L. Garces/P. Benedicto

12. Given the equilibrium output equation 𝑌 = 𝐶 + 𝐼 + 𝐺 + (𝑋 − 𝑀), where 𝑋 is the gross exports and
𝑀 is the gross imports, which of the following is/are true?

A. Domestic expenditures = 𝐶 + 𝐼 + 𝐺 and transactions with the rest of the world = 𝑋 − 𝑀

B. Domestic expenditures = 𝐶 + 𝐼 + 𝐺 and net exports = 𝑋 − 𝑀
C. 𝑌 − 𝐶 − 𝐼 − 𝐺 = 𝑋 − 𝑀 describes internal balance equals external balance
D. All of the above

13. What is the current account balance? Note that 𝑅 is net international transfer receipts and 𝑇 is
taxes net of transfer payments.

A. 𝑌 + 𝑅 − 𝑇 = 𝐶 + 𝐼 + (𝐺 − 𝑇) + (𝑋 + 𝑅 − 𝑀)
B. 𝐶+𝐼
C. 𝑿+𝑹−𝑴
D. None of the above
 University of the Philippines
SCHOOL OF ECONOMICS

Economics 100.1
1st Semester, AY 2021-2022
QUIZ #3

Prof. MS Gochoco-Bautista J. Abong/L. Garces/P. Benedicto

SHORT ANSWERS AND COMPUTATIONS

Instructions: Give short answers (in 2 to 3 sentences if possible and/or with the required graph/s) to the
following questions. Be sure to put your complete answers in your answer sheet, including all graphs. For
questions requiring computations, show your complete solution and readable answers to earn full merits.

A. Investment Demand and Related Concepts

1. Ferdi wants to borrow ₱ 400. He says that his children will pay me back ₱ 608.35 three years from
now. At what interest rate should I agree on?

We derive the interest rate from the formula for the future value of the loaned amount:

⟹ 𝐹𝑉 = 𝑃(1 + 𝑟)𝑡
⟹ ₱ 603.35 = ₱ 400(1 + 𝑟)3
₱ 603.35
⟹ (1 + 𝑟)3 =
₱ 400
3 ₱ 603.35
⟹1+𝑟= √
₱ 400

3 ₱ 603.35
⟹𝑟= √ −1
₱ 400
⟹ 𝒓 ≈ 𝟎. 𝟏𝟒𝟔𝟗𝟓𝟒𝟕𝟔𝟔

Hence, the interest rate must be approximately 15% so that the payment after three years is worth the
present value of the loaned amount.

2. I found a dilapidated building in the middle of a sad village. To make the villagers happy, I am
thinking of opening a movie house using that dilapidated building, but I would need financing to
continue with the project. The interest rate today is low at 2% because the Central Bank took
expansionary measures to recover from the pandemic. I would need ₱ 1,000,000 to transform the
building into a movie house, and it is projected that the revenue from a year of operation would
be ₱ 2,900 per day of operation.

A. What would by net profit be from proceeding with the investment. Should I proceed with the
investment?

To calculate the net profit, we need to calculate first the gross revenue and total costs of the investment:

➢ Gross revenues are derived by multiplying the revenues from daily operations by the number
of days of operations:

⟹ 𝑅Gross = ₱ 2,900 × 365 days

⟹ 𝑅Gross = ₱ 1,058,500
 University of the Philippines
SCHOOL OF ECONOMICS

Economics 100.1
1st Semester, AY 2021-2022
QUIZ #3

Prof. MS Gochoco-Bautista J. Abong/L. Garces/P. Benedicto

➢ Total investment costs are calculated as the compounded amount of the cost of obtaining the
investment after one (1) year of operations at the prevailing interest rate:

⟹ 𝐶Total = ₱ 1,000,000(1 + 0.02)

⟹ 𝐶Total = ₱ 1,020,000

➢ Net profit (𝝅𝐍𝐞𝐭 ) is calculated as the difference between the gross revenues and total
investment costs:
⟹ 𝜋Net = 𝑅Gross − 𝐶Total
⟹ 𝜋Net = ₱ 1,058,500 − ₱ 1,020,000
⟹ 𝝅𝐍𝐞𝐭 = ₱ 𝟑𝟖, 𝟓𝟎𝟎

Since 𝝅𝐍𝐞𝐭 > 𝟎, I proceed with the investment.

B. Suppose the interest rate increased from 2% to 6% on the day I went to the bank to make the
loan. What will happen to my net profit? Should I still proceed with the investment? How does
the investment demand schedule change? Why does it change this way?

To calculate the net profit with the new interest rate, we retain the gross revenues and calculate the total
costs of the investment at the new interest rate:

➢ Total investment costs are calculated as the compounded amount of the cost of obtaining the
investment after one (1) year of operations at the new interest rate:

⟹ 𝐶Total (New) = ₱ 1,000,000(1 + 0.06)

⟹ 𝐶Total (New) = ₱ 1,060,000

➢ Net profit [𝝅𝐍𝐞𝐭 (𝐍𝐞𝐰) ] is calculated as the difference between the gross revenues and total
investment costs at the new interest rate:
⟹ 𝜋Net (New) = 𝑅Gross − 𝐶Total (New)
⟹ 𝜋Net (New) = ₱ 1,058,500 − ₱ 1,060,000
⟹ 𝝅𝐍𝐞𝐭 (𝐍𝐞𝐰) = − ₱ 𝟏, 𝟓𝟎𝟎

Since 𝝅𝐍𝐞𝐭 (𝐍𝐞𝐰) < 𝟎, I do not proceed with the investment.

Holding other factors constant, when the interest rate increased, the quantity of investment demanded
decreased because investment projects now become more costly.

C. Suppose the Central Bank governor changed his mind and reverted it back to 2% just before I
left the bank, but taxes suddenly go up to 10% for building commercial establishments in sad
villages. Should I proceed with the investment? How will the investment demand schedule
change for sad villages?
 University of the Philippines
SCHOOL OF ECONOMICS

Economics 100.1
1st Semester, AY 2021-2022
QUIZ #3

Prof. MS Gochoco-Bautista J. Abong/L. Garces/P. Benedicto

After-tax net profits from the investment will be deducted with the amount of taxes levied on gross
revenues:

⟹ 𝜋Net (After tax) = 𝜋Net − (𝑡)(𝑅Gross )

⟹ 𝜋Net (After tax) = ₱ 38,500 − (0.10)(₱ 1,058,500)
⟹ 𝜋Net (After tax) = ₱ 38,500 − ₱ 105,850
⟹ 𝝅𝐍𝐞𝐭 (𝐀𝐟𝐭𝐞𝐫 𝐭𝐚𝐱) = − ₱ 𝟔𝟕, 𝟑𝟓𝟎

Since 𝝅𝐍𝐞𝐭 (𝐀𝐟𝐭𝐞𝐫 𝐭𝐚𝐱) < 𝟎, I do not proceed with the investment. With the imposition of taxes, the
investment demand curve shifts down.

B. Aggregate Demand and The Multiplier Model

1. Refer to the figure below to answer the questions that follow:

A. Explain the relevance of the 45°-line.

Any point on the 45°-line depicts a vertical distance exactly equal to the horizontal distance – that is,
at any point on the 45° line, expenditures (aggregate demand) exactly equal GDP (output or income).
Where the 𝐴𝐷 curve intersects with the 45°-line, the economy is in equilibrium.
 University of the Philippines
SCHOOL OF ECONOMICS

Economics 100.1
1st Semester, AY 2021-2022
QUIZ #3

Prof. MS Gochoco-Bautista J. Abong/L. Garces/P. Benedicto

B. Describe the economy at points A, B, and C. What happens in each scenario?

➢ At point A, the economy is in disequilibrium because spending is above output. Consumers

are buying more goods than businesses can provide at their current level of production.
Businesses will increase their production and hence, output will increase until it reaches
equilibrium. Graphically, this would be a north-east movement along the 𝐴𝐷 curve from point
A to point B.

➢ At point B, the economy is in equilibrium – that is, desired spending or 𝐴𝐷 equals actual
output. This level of output will persist until there are changes in the forces affecting the
economy.

➢ At point C, the economy is in disequilibrium because output is greater than spending.

Businesses are producing more than what consumers are willing to buy and so they will
decrease their output until it reaches equilibrium. Graphically, this would be a south-west
movement along the 𝐴𝐷 curve from point C to point B.

2. As a new Doña, I decided to hire someone unemployed to hold my umbrella to keep me sheltered
from sunlight when I take my morning walks. I pay them ₱ 1,500 per day. If the umbrella holder’s
marginal propensity to consume (MPC) is 3⁄4, and the MPC of the people she hired is 3⁄4, and the
MPC of the rest of the world is also 3⁄4.

A. What is the value of the multiplier?

The [expenditure] multiplier is equal to:

1 1
⟹ 𝐸𝑀 = ≡
1 − 𝑀𝑃𝐶 1 − 3⁄
4
1
⟹ 𝐸𝑀 =
1⁄
4
⟹ 𝑬𝑴 = 𝟒

B. By how much did total spending increase?

The change in total spending is given by:

1 1
⟹ Δ𝑌 = ₱ 1,500 ( ) = ₱ 1,500 ( )
1 − 𝑀𝑃𝐶 1 − 3⁄4
1
⟹ Δ𝑌 = ₱ 1,500 ( )
1⁄
4
⟹ Δ𝑌 = ₱ 1,500(4)
⟹ 𝚫𝒀 = ₱ 𝟔, 𝟎𝟎𝟎
 University of the Philippines
SCHOOL OF ECONOMICS

Economics 100.1
1st Semester, AY 2021-2022
QUIZ #3

Prof. MS Gochoco-Bautista J. Abong/L. Garces/P. Benedicto

3. I bought an oven worth ₱ 5,000 so that I could bake 1,000 more pieces of cupcakes. The revenue
from selling these cupcakes is ₱ 10,000. What is the value of the multiplier?

The change in exogenous investment, denoted by 𝚫𝑰, is equal to ₱ 5,000 while the change in income, denoted
by 𝚫𝒀 is ₱ 10,000. Hence, the multiplier, denoted by EM, is equal to:
Δ𝑌 ₱ 10,000
⟹ 𝐸𝑀 = =
Δ𝐼 ₱ 5,000
⟹ 𝑬𝑴 = 𝟐

4. Let consumption be denoted by the function 𝐶 = 200 + 0.9𝑌 while investment is constant at
𝐼 = 300. Show that the equilibrium income in the economy is 5,000 using the:

A. Total expenditure approach:

In equilibrium:
⟹ 𝑌 = 𝐴𝐷 ≡ 𝐶 + 𝐼
⟹ 𝑌 = 200 + 0.9𝑌 + 300
⟹ 𝑌 − 0.9𝑌 = 500
⟹ 𝒀∗ = 𝟓, 𝟎𝟎𝟎

B. S = I approach:

In equilibrium:
⟹𝑆=𝐼
⟹𝑌−𝐶 =𝐼
⟹ 𝑌 − (200 + 0.9𝑌) = 300
⟹ 𝑌 − 0.9𝑌 = 300 + 200
⟹ 0.1𝑌 = 500
⟹ 𝒀∗ = 𝟓, 𝟎𝟎𝟎

5. The government is trying to find solutions to increase the economy’s output. Its options are either
(a) to increase government spending by ₱ 150 per capita or (b) to decrease the proportional income
tax from 5% to 1%. Assuming that each person earns ₱ 50,000 per month and has a consumption
function given by 𝐶 = 50 + 0.8𝑌𝐷 , where 𝑌𝐷 denotes disposable income, and that there are 1,000
people in the economy, will both solutions yield the same impact on output?

The impact of the increase in government spending by ₱ 150 per capita on the economy’s output is given by:
1 1
⟹ Δ𝑌 = 1,000(Δ𝐺) ( ) = 1,000(₱ 150) ( )
1 − 𝑀𝑃𝐶 1 − 0.8
1
⟹ Δ𝑌 = ₱ 150,000 ( )
0.2
⟹ 𝚫𝒀 = ₱ 𝟕𝟓𝟎, 𝟎𝟎𝟎
 University of the Philippines
SCHOOL OF ECONOMICS

Economics 100.1
1st Semester, AY 2021-2022
QUIZ #3

Prof. MS Gochoco-Bautista J. Abong/L. Garces/P. Benedicto

Meanwhile, the impact of the decrease in proportional income tax from 5% to 1% can be examined from the
change in consumption using the consumption function, which is given by:
⟹ Δ𝐶 = 1000{[50 + 0.8(₱ 50,000 − (0.01 × ₱ 50,000))] − [50 + 0.8(₱ 50,000 − (0.05 × ₱ 50,000))]}
⟹ Δ𝐶 = 1000{[50 + 0.8(₱ 50,000 − ₱ 500)] − [50 + 0.8(₱ 50,000 − ₱ 2,500)]}
⟹ Δ𝐶 = 1000{[50 + 0.8(₱ 49,500)] − [50 + 0.8(₱ 47,500 )]}
⟹ Δ𝐶 = 1000{[50 + ₱ 39,600] − [50 + ₱ 38,000]}
⟹ Δ𝐶 = 1000(₱ 1,600)
⟹ 𝚫𝑪 = ₱ 𝟏, 𝟔𝟎𝟎, 𝟎𝟎𝟎

6. Suppose that households in the Philippines save 10% of every additional peso in income that they
receive. What will happen to the country’s aggregate demand if there is a ₱ 4-billion increase in
lump-sum taxes?

The given information implies that 𝑀𝑃𝑆 = 0.1 and 𝑀𝑃𝐶 = 0.9. We use the formula for the tax multiplier
to determine the impact of the increase in lump-sum taxes on aggregate demand:
Δ𝑌 𝑀𝑃𝐶 𝑀𝑃𝐶
⟹ =− =−
Δ𝑇 1 − 𝑀𝑃𝐶 𝑀𝑃𝑆
𝑀𝑃𝐶
⟹ Δ𝑌 = −(Δ𝑇) ( )
𝑀𝑃𝑆
0.9
⟹ Δ𝑌 = −(₱ 4 billion) ( )
0.4
⟹ Δ𝑌 = − (₱ 4 billion)(9)
⟹ Δ𝑌 = − ₱ 36 billion

Hence, the change in aggregate demand (or output) given an increase in lump-sum taxes is − ₱ 36 billion.