Currently, a government\'s budget is balanced. The marginal propensity to consum

Question

Currently, a government's budget is balanced. The marginal propensity to consume is 0.75. The government has determined that each additional $10 billion in new government debt it issues to finance a budget deficit pushes up the market interest rate by 0.10 percentage points. It has also determined that every 0.10 (one-tenth) percentage-point change in the market interest rate generates a change in planned investment expenditures equal to $1 billion. Finally, the government knows that to close a recessionary gap and take into account the resulting change in the price level, it must generate a net rightward shift in the aggregate demand curve equal to $250 billion Assuming that there are no direct expenditure offsets to fiscal policy, calculate the increase in government expenditures necessary to close the recessionary gap. (Hint: How much private investment spending will each $10 billion increase in government spending crowd out?) $billion. (Enter your response rounded to two decimal places.)

Explanation / Answer

Net change in spending of

m = 0.10
X = 1 billion.
(1-MX) = (1-0.10) = $0.90

We know that the AD curve will shift to the right by the net change in spending multiplied by the multiple, which =

1/1- mpc (0.25) = 4

Therefore , the net increase in AD due to the 1 billion increase in government expenditures is = 1-mx/1-mpc = 3.6 which is the net multiplier.

To close the recessionary gap, government spending will have to increase by an amount equal to

250/3.6 = $69.44

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