Question

In 2009 when President Obama entered the White House, the U.S. had entered the worst recession since the great depression. Although there were differing opinions on the size of the economic stimulus needed, the government passed an economic stimulus totaling $787 billion. The program included increases in government expenditures on goods and services, tax cuts and income/transfer payments. Assume MPC is .75 All the following problems require mathematical calculations.

House, the U.S. had entered the worst recession since the great depression. Although there were differing opinions on the size of the economic stimulus needed, the government passed an economic stimulus totaling $787 billion. The program included increases in government expenditures on goods and services, tax cuts and income/transfer payments. Assume MPC is .75 All the following problems require mathematical calculations. a) How would a $237 billion tax cut have affected AD ? b) How would an increase in unemployment benefits (transfer payment) of $40 billion affected AD ? c) Assume the AD Shortfall in 2009 was $5400 billion. What change in government expenditures on goods and services would you have recommenced? d) Assume the AD Shortfall in 2009 was $5400 billion. What change in income/transfer payments would you have recommended ? e) Assume the AD Shortfall in 2009 was $5400 billion. What change in income taxes would you have recommenced?

Answer 1

a) we know that tax Multiplier = - MPC / 1- MPC

Given MPC = 0.75

So tax Multiplier = -0.75 / 1- 0.75 = -3

We also know that tax multiplier = ∆Y/ ∆T

So -3 = ∆Y / -237 so ∆Y = 711

It means when government decrease the tax by 237 the GDP increase by 711

b) transfer payment Multiplier(k) = MPC / 1- MPC

So 0.75 / 1-0.75 = 3

We also know that k = ∆Y/∆R

So 3 = ∆Y / 40 so ∆Y = $120

When transfer increase by $40 the GDP(∆Y) increase by $120

c) expenditure multiplier (k) = 1 / 1-MPC = 1/ 1-0.75 = 4

We also know k = ∆Y/ ∆G put k = 4 and ∆Y = $5400

4 = $5400 / ∆G so ∆G = $1350

Government need to increase expenditure by $1350 to increase the GDP(∆Y) = 5400

d) we know that transfer payment Multiplier (k) = 3 ( solve in question b)

Here we have ∆Y = $5400

Transfer payment Multiplier (k) = ∆Y / ∆R

3 = 5400 / ∆R so ∆R = $1800

It means government need to increase transfer payment by 1800 to increase GDP by 5400

e) we have tax Multiplier = -3

Tax multiplier (k) = ∆Y /∆T

Given ∆Y = $5400

-3 = 5400 / ∆T so ∆T = - $1800

It means government need to decrease tax by $1800 to increase the GDP by $5400.