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Chapter 13: Q.2 - Problems (page 302)

Assume that MPC= 45when answering the following questions.

a. If government expenditures rise by \( 2 billion, by how much will the aggregate expenditure curve shift upward? By how much will equilibrium real GDP per year change?

b. If taxes increase by \) 2 billion, by how much will the aggregate expenditure curve shift downward? By how much will equilibrium real GDP per year change?

Short Answer

Expert verified

a. by$10trillion

b. by$8billion

Step by step solution

01

introduction

Tax multiplier addresses sway on Real Output because of progress in the Tax rate.

Government Multiplier addresses change in Real GDP because of progress in Government Expenditure

02

explanation part (a)

Given,

MPC = 45

Change in government expenditures role="math" localid="1651984325430" ∆G=$2billion

we know, ΔYΔG=11-MPC

ΔY2=11-0.8=10

equilibrium real GDP per year will change by$10trillion

03

explanation part (b)

Increase in the taxes = $2billion

MPC= 0.8

now

MPS=1−MPCMPS=1=0.8MPS=0.2

Tax multiplier =

△Y△T=−MPCMPS

ΔY2=−0.80.2=−4

role="math" localid="1651985298350" ⇒△Y=−8

equilibrium real GDP per year changes by$8billion

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Most popular questions from this chapter

Determine whether each of the following is an example of a situation in which a direct expenditure offset to fiscal policy occurs.

a. In an effort to help rejuvenate the nation's railroad system, a new government agency buys unused track, locomotives, and passenger and freight cars, many of which private companies would otherwise have purchased and put into regular use.

b. The government increases its expenditures without raising taxes. To cover the resulting budget deficit, it borrows more funds from the private sector, thereby pushing up the market interest rate and discouraging private planned investment spending.

c. The government finances the construction of a classical music museum that otherwise would never have received private funding.

Describe how certain aspects of fiscal policy function as automatic stabilizers for the economy

Consider the diagram below, in which the current short-run equilibrium is at point A, and answer the questions that follow.

a. What type of gap exists at point A?

b. If the marginal propensity to save equals 0.02, what change in government spending financed by borrowing from the private sector could eliminate the gap identified in part (a)? Explain.

Currently, a government's budget is balanced. The marginal propensity to consume is \(0.80. The government has determined that each additional \)10 billion it borrows to finance a budget deficit pushes up the market interest rate by role="math" localid="1651613391961" 0.1 percentage point. It has also determined that every role="math" localid="1651613378175" 0.1-percentage point change in the market interest rate generates a change in planned investment expenditures equal to \(2 billion. Finally, the government knows that to close a recessionary gap and take into account the resulting change in the price level, it must generate a net rightward shift in the aggregate demand curve equal to \)200 billion. Assuming that there are no direct expenditure offsets to fiscal policy, how much should the government increase its expenditures? (Hint: How much private investment spending will each $10 billion increase in government spending crowd out?)

Recall that the Keynesian spending multiplier equals 1 /(1-MPC). Suppose that in panel (a) of Figure 13-1, the government determined that the amount by which the AD curve had to be shifted directly rightward from the point E1 was equal to \(1.0 trillion. If the government decided that a \)0.2 trillion increase in real government spending was required to generate this shift, what must be the value of the MPC?
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