Question

1. Suppose the MPC is 0.8 and the crowding out effect is $30 billion. The government aims to increase GDP by $250 billion.

a) Calculate the fiscal multiplier

b) how much the government needs to increase spending to increase GDP by $250 billion

c) Calculate the tax cut multiplier,

d) How much the government needs to cut taxes to increase GDP by $250 billion?

e) Explain why the tax multiplier is smaller than the fiscal multiplier.

f) If you were the economic advisor to the president, which policy will you propose to the president to achieve the $250 increase in GDP target? Increase in government spending or tax cut? Why?

g) What policy is the government trying to embark on?

Answer 1

Given information,

MPC = 0.8

Crowding out = $30 billion

Change in GDP = $250billion

A)Fiscal multiplier = 1 / (1 - MPC)

= 1 / (1 - 0.8)

= 1 / 0.2

= 5

B) (∆ in GDP)/ (∆ in govt spending) = Fiscal multiplier

250/∆ in govt spending = 5

Therefore, ∆ in govt spending =250/5

Since there is crowding out of $30 billion need to increase GDP by additional 30 as well and multiplier effect will apply to that also.

Hence, Change in govt.spending =( 250+30)/5

= $56 billion

Government need to increase spending by $56 billion to increase GDP by $250 billion.
C)Tax multiplier = - MPC / (1 - MPC)

= - 0.8 / 0.2

= - 4
D.) Similarly, as part b

Change in taxes = 250+30/4

=$70 billion

Government need to cut taxes by $70 billion to increase GDP by $250 billion.

Note: As per guidelines I have answered first four completely. Please post next parts in another query.