You are given the following information about an economy, whose government as co

Question

You are given the following information about an economy, whose government as committed to a Balanced budget financial policy MPC = 0.85 MPE = 0.6 Suppose that there in a recessionary gap and the government has decided to changes the amount of government spending and net tax ravened by $ 10 billion simultaneously to chose the GDP gap. Should the government increase or decrease government spending and net tax revenant of government to achieve the desired outcomes? Given your answer to the preceding question, will the recommended change have an expansionary or contractionary impact on the economy?

Explanation / Answer

Answer 1:

Since the economy is in recession, the government should increase the spending and reduce the tax revenue to increase the overall aggregate demand in the economy. This will close to close the recessionary gap.

The given change will have an expansionary effect on the economy.

Answer 2:

In the case of Balanced Budget Multiplier which is equal to 1, change in income = change in government spending.

So, the income will increase by $10 billion.

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