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Chapter 13: Q.18 (page 298)

Recall that the Keynesian spending multiplier equals 1 /(1-MPC). Suppose that in panel (b) of Figure 13-1, the government knows that the MPC is equal to 0.75 and that the amount of the horizontal distance that the AD curve had to be shifted directly leftward from point E1 was equal to $1.0 trillion. What is the reduction in real government spending required to have generated this shift?

Short Answer

Expert verified

The reduction in real government spending required is$0.25trillion

Step by step solution

01

introduction

Spending Multiplier: It is a proportion of the degree to which GDP changes because of an adjustment of arranged venture spending or government spending. Marginal Propensity to Consume alludes to the extent of the absolute expansion in discretionary cash flow that families give to utilization.

02

explanation

We know,

MPC = 0.75

The spending multiplier can be calculated as,

role="math" localid="1651935485004" =11−MPC=11−0.75=4

the decline in government expenditure be∆Gand leftward shift on the AD curve be∆AD=$1trilion

the decline in government expenditure

role="math" localid="1651935751198" ΔG=ΔADspending multiplier=14=0.25

The reduction in real government spending required is$0.25trillion

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Most popular questions from this chapter

A government has found that 2 months elapse before it can identify a problem to address with policy action. It has been found that 1 month is required to determine the appropriate policy action. Finally, it has been concluded that the total time required between the initial presence of the problem and the effects of a policy action to be realized is 12 months. What are the remaining policy time lag and its duration?

Determine whether each of the following is an example of discretionary fiscal policy action.

a. A recession occurs, and government-funded unemployment compensation is paid to laid-off workers.

b. Congress votes to fund a new jobs program designed to pat unemployed workers to work.

c. The Federal Reserve decides to reduce the quantity of money in circulation in an effort to slow inflation.

d. Under powers authorized by an act of Congress, the president decides to authorize an emergency release of funds for spending programs intended to head off economic crises.

List and define fiscal policy time lags and explain why they complicate efforts to engage in fiscal "fine tuning".

Assume that the Ricardian equivalence theorem is not relevant. Explain why an income-tax-rate cut should affect short-run equilibrium real GDP.

Assume that equilibrium real GDP is \( 18.2 trillion and full-employment equilibrium (F E) is \) 18.55 trillion. The marginal propensity to save is 17. Answer the questions using the data in the following graph.

a. What is the marginal propensity to consume?

b. By how much must new investment or government spending increase to bring the economy up to full employment?

c. By how much must government cut personal taxes to stimulate the economy to the full employment equilibrium?
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