Question

Assume that a hypothetical economy with an MPC of 0.8 is experiencing severe recession. a. By how much would government spending have to rise to shift the aggregate demand curve rightward by $25 billion? billion How large a tax cut would be needed to achieve the same increase in aggregate demand? Instructions: Round your answer to 2 decimal places and enter your answer as a positive number. Tax cut - ARRASANTA billion. b. Determine one possible combination of government spending increases and tax increases that would accomplish the same goal without changing the amount of outstanding debt. Increase government spending by billion. Increase taxes by billion

Answer 1

a) MPC (b) = 0.8. , $\Delta$ Y = 25 billion. According to the Keynesian cross multiplier,

AY/AG = 1/(1-6)

$\Delta G$ = $5 billion.

Let the tax cut be $\Delta T$ . According to KCM, .

AY/AT = -b/(1-6)

Tax cut = $6.25 billion.

b) If change in Government expenditure = change in taxes = x , it would create a change in aggregate demand without changing the amount of government debt. TOtal change in AD = $\Delta$ Y= 25 billion

Therefore, 5$\Delta G$ - 4$\Delta T$ = 25, HEnce , x = $25 billion.

Increase in government spending = $25 billion

Increase taxes by $25 billion.