Question

*** puci CHICULE como ption 12. The economy is in a deep recession. In order to close the output gap, the government is planning on sending a cheque (money) to all households, worth a total of 100. What is the total impact of this policy on equilibrium output if the multiplier is equal to 1.5. y consumption 13. Explain in plain words how the impact of the fiscal policy described above depends on the MPC. Tax multiplier 14. Describe the equilibrium process in the AE model.

Answer 1

12.

Multiplier = 1.5

The impact will be to increase the equilibrium output.

The maximum impact of the policy to increase the equilibrium output = Government spending * multiplier

The maximum impact of the policy to increase the equilibrium output = 100*1.5

The maximum impact of the policy to increase the equilibrium output = 150

===

13.

The impact of fiscal policy depends upon the MPC, in a way that higher the MPC, leads to higher the increase in equilibrium output. It happens, because a higher MPC value means a bigger size of the multiplier. It makes a bigger positive impact of the MPC upon the equilibrium output.

For example,

if MPC = .5

Then,

Multiplier = 1/(1-MPC) = 1/(1-.5) =2

But, it MPC increases to .8

Then,

Multiplier = 1/(1-MPC) = 1/(1-.8) = 5

Above illustration shows that increased value of MPC increases multiplier that brings bigger and positive impact upon the equilibrium GDP.

===

14.

In AE model, equilibrium process is achieved when income becomes equal to total expenditure. Here, total expenditure includes consumption (C), government spending (G) and investments (I) for a closed economy.

So,

At equilibrium,

Y = C+G+ I

Here, C = Autonomous consumption (AC) + Disposable income (DY)

Y = (AC + MPC*DY) + G+I

Here, DY = T - tax rate

Further, at equilibrium, savings = investment in AE model.