An economy is initiaity at full employment, but a decrease in planned Investment

Question

An economy is initiaity at full employment, but a decrease in planned Investment spending (a component of autonomous expenditure) pushes the economy into recession Assume that the marginal propensity to consume mpc, or this econ iso7s and that the muitpler is a. How large is the recessionary gap after the fail in planned investment The recessionary gap is b. By howw much would the goverment have to change its purchases to restore the economy to full employment? The (Cick to selectg·in purchases shoid be lock to select" the nain planned investment. times the size of the fall in planned investment Atematively, by how much would the government have to change taxes? Instruction: Round your response to the nearest whole percen The gevemment wouis have to (Cick to select taes by an amount thatpercent (Cick to select)the decine in planned invest d. Suppose that the government's budget is initiality in balance, with government spending equai to tases collected. A baianced-budget law forbids the govemment from running a deficit Is there anyting that fiscal policymakers could do to restore full employment in this economy assuming they do not want to violate the balanced-budget la Decrease government spending and increase taxes by the same armont, which wil resu a net increase in asaononous experduo without offsetting the balanced budget Decrease both govemment spending and taxes by the same amount, which will result in a net increase in autonomous expenditure withoul offseting the balanced budet Increase both govemment spending and taxes by the same amount, which will result in a net increase in autonomous expenditure without offisetting the balanced budget Decrease taes whie increase g government spenhg by a geater amount which wil oesain a ncrease a.tonomos ependtue witout offsemng balanced budget

Explanation / Answer

(a) Spending multiplier = 4

It means, when planned investment spending decreases by 1 unit, output decreases by 4 units. Therefore,

Recessionary gap is 4 times the size of the fall in planned investment.

(b) The increase in government purchase should be Equal to (100% of) the fall in planned investment.

[Both planned investment and government purchases are autonomous spendings, therefore a $X fall in one of them can be exactly offset by a $X rise in the other, to restore full employment equilibrium].

(c) Tax multiplier = - MPC / (1 - MPC) = - 0.7 / (1 - 0.75) = - 0.75 / 0.25 = - 3

It means, tax decreases by 1 unit, output increases by 3 units. Therefore,

Government has to Decrease taxes by an amount that is 300% the decline in planned investment.

(d) Increase both government spending and taxes by same amount, which will result in net increase in autonomous expenditure (Since Spending multiplier > Tax multiplier), without offsetting balanced budget.

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