QuiaBiquiz probGuid-Q4PLCOAB01010000002e7alb3300500008ct-wballey2-00128ck 2,1462

Question

QuiaBiquiz probGuid-Q4PLCOAB01010000002e7alb3300500008ct-wballey2-00128ck 2,1462546526759 AC14 Keep the Highest:3 2. Fiscal policy Suppose a hypothetical economy is currently in a recessionary gep of 564 biltion. Four economists agree that expansionary fiscal policy can increase total spending and mave the ecanomy out of recession, but thay are debating which type of expansionary policy shoule be used. Economist A believes that the government spending multiplier is 8 and the tax multiplier is 2. Ecanomist 8 beieves thet the government spending multipier is 4 and the tax multiplier is 8 Compute the amount the government would have to increase spending to clase the output gep according to eech econemist's belier. Then, for each scenania, compute the size of the tex cut that would echieve this same effect Policy Options for Closing Output Gap Increase in Spending Spending Hultiplier Tax Multiplier (Billions of dollars) (Bllions of dollars Ecenemist B Economist C fevors tex cuts over increases in govemment spending. This means that Econemist C kely believes thet O Tax cuts induce investment spending and improve workers incentives O A dollar in tax cuts immedietely and fully ades to aggregate demend. he web and Windows

Explanation / Answer

(1)

(a) Economist A:

Increase in spending = $64 billion / 8 = $8 billion

Tax cut = $64 billion / 2 = $32 billion

(b) Economist B:

Increase in spending = $64 billion / 4 = $16 billion

Tax cut = $64 billion / 8 = $8 billion

(2) Economist C believes that Tax Cut immediately adds to aggregate demand.

(3) Economist D believes that increase in government spending completely crowds out private sector spending (higher government spending causes budget deficit which is financed by borrowing, which raises interest rate & lwoers investment demand from private sector. This is called crowding out effect, which results in lower net increase in aggregate demand).

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