15. To eliminate an AD shortfall of $120 billion when the economy has an MPC of

Question

15. To eliminate an AD shortfall of $120 billion when the economy has an MPC of 0,85 and MPI of 0.10, the government should decrease taxes by: A) $400 billion. B) S120 billion. C) S30 billion. D) $40 billion. 16. To el iminate an AD shortfall of S100 billion when the economy has an MPC of 0.90 and MPI of 0.10, the government should increase transfer payments by: A) $25 billion. B) S100 billion C) $80 billion. D) S20 billion. 17. Assume the MPC is 0.85 and MPI is 0.10, taxes increase by $100 billion, and government spending increases by $100 billion. Aggregate demand will: A) Increase by $400 billion B) Decrease by $400 billion. C) D) Increase by $100 billion. Not change 18. Suppose the government decides to increase taxes by ss0 billion and to increase transfer payments by $50 billion. What effect would there be on aggregate demand? A) Zero. B) S50 billion increase. C) More than $50 billion increase after the multiplier effect. D) $50 billion decrease. 19. Suppose the MPS is 0.1 and the MPI is 0.1. If the government stimulates the economy with $200 billion in increased transfer payments, aggregate expenditure would rise by: A) $200 billion. B) $400 billion. C) $800 billion. D) S1,000 billion. Use the following to answer questions 20-23 Figure 11.2 AS PE AD2 ADI QE QF REAL GDP According to Figure 11.2, a shift from ADi to AD2 will: A) Move equilibrium to QF B) Eliminate the GDP gap because of the increase in output. C) Move equilibrium to point Y because of an increase in the price level. D) Move the economy to point Y and then the market mechanism will move the economy to point Z 20.

Explanation / Answer

15.Option D: $40 billion

Change in AD= Tax multiplier x change in T
Given MPC=0.85 & MPI=0.10
Real MPC=(0.85-0.10)=0.75
That gives
120=(-MPC/1-MPC )x Change in T
120= (.75/1.75) x Change in T
120 = 3x Change in T
This gives
Change in T=120/3=40
So the government should decrease taxes by $40 billion i.e option D

16. Option : $25 billion

Given MPC=0.90 & MPI=0.10

This gives actual MPC=(0.90-0.10)=0.80

So now,

(1/(1-.8)=5

100/5=20;

20/.8=25

So the government should increase transfer payments by $25 billion i.e option A

17. Option C:Increase by $100 billion

Given MPC=0.85 and MPI=0.10

Actual MPC=(0.85-0.10=0.75)

The balanced budget multiplier is equal to 1.So, in this case, government expenditures combined increased by a $100 billion with an equivalent increase in taxes increases aggregate demand by $100 billion.

18. Option A: Zero

This as tax is equal to the transfer payments,there will be no impact

(Tax=transfer payments)

19. Option A: $200 billion

The value of the multiplier is equal to 1 divided by 1 minus the marginal propensity to consume. If the MPC is .1, the multiplier is 1. The amount that AD increases from fiscal stimulus is equal to the multiplier times the new spending injection or fiscal stimulus. So if the government increases spending by $200 billion, the total change in spending will by $200 billion (1× 200)

20. Option C: Move equilibrium to point Y because of an increase in the price level.

We would get a shift from AD1 to AD2, if the aggregate demand increased by the amount of the recessionary GDP gap, Leaving the economy short of full employment (QF), The new equilibrium would occur at point Y.

So these increased demand pushes the prices up instead of the output.

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