Question

Two economists estimate the government expenditure multiplier and come up with different results. One estimates the multiplier at 0.8, while the other comes up with an estimate of 1.25. Explain why these estimates are different in terms of the assumptions that each economist is making. A. Compared to the first economist, the second economist must be assuming either a smaller induced increase in consumption, a larger crowding out effect, or both. B. Compared to the first economist, the second economist must be assuming either a larger induced increase in consumption, a smaller crowding out effect, or both. C. Compared to the first economist, the second economist is assuming a longer time frame for the effects of the increased expenditure to be observed. D. Unlike the first economist, the second economist must be assuming that the government expenditure is devoted to useful projects. If the current value of GDP is $13.28 trillion and the government is planning to increase spending by $800 billion (all in one year), the percentage increase in GDP using the multiplier estimate of the first economist is 4.82 percent. (Round your response to two decimal places.)

Answer 1

The first economist has estimated the value of government expenditure multiplier at 0.8 while the second economist has estimated the value of government expenditure multiplier at 1.25

The second economist has calculated higher value of the government expenditure multiplier.

This means second economist has assumed greater expansion of GDP with initial inccrease in government spending and lower leakages and crowding out effect.

Thus,

The correct answer is the option (B).

Current level of GDP = $13.28 trillion

Increase in government spending = $800 billion

Government expenditure multiplier = 0.8

Increase in GDP due to multiplier effect = Increase in government spending * Government expenditure multiplier = $800 billion * 0.8 = $640 billion or $0.64 trillion

Calculate the percentage increase in GDP -

% increase = [Increase in GDP/Current level of GDP] * 100 = [$0.64 trillion/$13.28 trillion] * 100 = 4.82%

Thus,

The percentage increase in GDP using the multiplier estimate of the first economist is 4.82 percent.

Current level of GDP = $13.28 trillion

Increase in government spending = $800 billion

Government expenditure multiplier = 1.25

Increase in GDP due to multiplier effect = Increase in government spending * Government expenditure multiplier = $800 billion * 1.25 = $1,000 billion or $1 trillion

Calculate the percentage increase in GDP -

% increase = [Increase in GDP/Current level of GDP] * 100 = [$1 trillion/$13.28 trillion] * 100 = 7.53%

Thus,

The percentage increase in GDP using the multiplier estimate of the second economist is 7.53 percent.