8. Assume that MPC = 0.9. If G increases by $100 billion and T increases by $100

Question

8. Assume that MPC = 0.9. If G increases by $100 billion and T increases by $100 billion, the equilibrium GDP ___ by $___ billion.

A. increases, 0                                     B. increases, 100                    

C.decreases, 100                                 D. decreases, 10               

9. Assume that MPC = 0.9. In order to increase the equilibrium GDP without changing the government budget deficit or surplus, we should ___ G by $100 billion and ___ T by $100 billion.

A. increase, increase                            B. increase, decrease

C.decrease, increase                            D.decrease, decrease

Could someone explain to me what the answers would be and why? Thanks!

Explanation / Answer

8. If G and T both increases by $100 billion and MPC= 0.9 ,

Then ,change in GDP by increase in G = 1/1-MPC (100) = (1/1-0.9 )(100) = 100/0.1 = 1000

Change in GDP by increase in T = (-MPC/ 1- MPC )(100) = (-0.9/ 1- 0.9) (100) =( -0.9/0.1 )/100 = -90 /0.1 = -900.

Therefore, the total change in GDP = 1000 -900 = 100 billion.

It implies that GDP increases by $100 billion. Hence, option (B) is correct.

9. When G increases by $100 billion and T increases by $100 billion.Then , there will be increase in equilibrium GDP by $100 billion but there is no change in budget . Because the increase in amount of G and T by the same amount, is called the balanced budget. Increase in G will compensate the increase in T.

Hence, option (A) is correct.

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