The consumption function in the economy is C = 50 + .9 (GDP) a) Suppose the econ

Question

The consumption function in the economy is C = 50 + .9 (GDP)

a) Suppose the economy has a recessionary gap of $500 million and policymakers want to increase create jobs and increase equilibrium output by using fiscal policy, by how much should they change government spending? Will they increase or decrease government spending? (2 points)

b) If they would rather use taxes, how would they use income taxes to increase equilibrium output by $500? Will they increase or decrease taxes?

c) Show by how much the government

Explanation / Answer

The consumption function in the economy is C = 50 + .9 (GDP)

a) Suppose the economy has a recessionary gap of $500 million and policymakers want to increase create jobs and increase equilibrium output by using fiscal policy, by how much should they change government spending? Will they increase or decrease government spending?

MPC=0.9

Multiplier = 1/1-MPC

   = 1/.1

   = 10

Assume spending =x

   10x = 500

x=500/10

=50

Govt should increase the spending by $50

b) If they would rather use taxes, how would they use income taxes to increase equilibrium output by $500? Will they increase or decrease taxes?

MPC = 0.9

Tax Multiplier =-MPC/1-MPC

   = -0.9/.1

   = 9

Assume change in the tax = x

   9x = 500

x=500/9

=55.55

govt should reduce the tax by $55.55

c) Show by how much the government

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