Question

1) You are hired by the Council of Economic Advisors (CEA) as an economic consultant. The chairperson of the CEA tells you that she believes the current unemployment rate is too high. The unemployment rate can be reduced if aggregate output increases. She wants to know what policy to pursue to increase aggregate output by $300 billion. The best estimate she has for the MPC is 0.8. Which of the following policies should you recommend?

a) Reduce taxes by $75 billion and to increase government purchases by $75 billion.

b) Reduce taxes by $75 billion.

c) Increase government purchases by $75 billion.

d) Reduce the budget deficit by $300 billion.

2) Assume that the MPC is 0.9. If government purchases increase by $100, equilibrium output ________; and if taxes increase by $100, equilibrium output ________.

a) increases by $400; decreases by $400

b) increases by $1,000; decreases by $900

c) increases by $900; decreases by $1,000

d) increases by $1,000; decreases by $1,000

Refer to the information provided in Figure 9.4 below to answer the questions that follow.



Figure 9.4


3) Refer to Figure 9.4. What is the value of the tax multiplier?

AEZ AE B + --- Aggregate expenditures ($ billions) 2,000 +-- 7001 400 K450 2,000 A Aggregate output ($ billions)

a) -8

b) -9

c) -2

d) -4

4) Refer to Figure 9.4. If aggregate expenditures are represented by AE1 and government spending increases by $100 billion, equilibrium aggregate output increases by $________ billion.

a) 800

b) 100

c) 300

d) 500

Answer 1

Answer-1 The correct option is b) Reduce taxes by $75 billion.

Government expenditure multiplier = 1/1-MPC = 1/1- 0.8 = 1/0.2 = 5

Increase in government purchases = 300/5 = $60

Tax Multiplier = -MPC/1-MPC = -0.8(5) = -4

Decrease in taxes = 300/4 = 75.

Answer-2 The correct option is b) increases by $1,000; decreases by $900

Output increase = (Government expenditure multiplier)*100

= (1/1-0.9 )*100

= $1000

Output decrease = (Tax multiplier )*100

= -0.9(10)*100

= $900

Answer-3 The correct option is d.) -4

MPC =0.8

Tax multiplier = -0.8/1-0.8= -0.8/0.2 = -4

Answer-4 The correct option is d) 500

Increase in output = (1/1-0.8)*100

   = 5*100

= 500