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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 is currently operating with an annual budget deficit of \(40 billion. The government has determined that every \)10 billion reduction in the amount it borrows each year would reduce the market interest rate by 0.1 percentage point. Furthermore, it has determined that every 0.1-percentage-point change in the market interest rate generates a change in planned investment expenditures in the opposite direction equal to \(5 billion. The marginal propensity to consume is 0.75. Finally, the government knows that to eliminate an inflationary gap and take into account the resulting change in the price level, it must generate a net leftward shift in the aggregate demand curve equal to \)40 billion. Assuming that there are no direct expenditure offsets to fiscal policy, how much should the government increase taxes? (Hint: How much new private investment spending is induced by each $10 billion decrease in government spending? )

Based on Schwinn's conclusions, is the government likely to be able to boost real GDP with an increase in government spending if it has raised and lowered its expenditures a number of times in previous months? Explain your reasoning.

2. Why do you suppose that many economists perceive a trade-off between short-term stabilization benefits of unemployment compensation and a contribution to a higher unemployment rate in the long run?

Use traditional Keynesian analysis to evaluate the effects of discretionary fiscal policies.

Determine whether each of the following is an example of an automatic fiscal stabilizer.

a. A federal agency must extend loans to businesses whenever an economic downturn begins.

b. As the economy heats up, the resulting increase in equilibrium real GDP per year immediately results in higher income tax payments, which dampen consumption spending somewhat.

c. As the economy starts to recover from a severe recession and more people go back to work, government-funded unemployment compensation payments begin to decline.

d. To stem an overheated economy, the president, using special powers granted by Congress, authorizes emergency impoundment of funds that Congress had previously authorized for spending on govemment programs.
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