Assume out a hypothetical economy with an MPC or 09 is experiencing severe reces

Question

Assume out a hypothetical economy with an MPC or 09 is experiencing severe recession Instructions: in pact a round yow answers to 2 decimal places Enter positive numbers In part b, enter your answers as whole numbers a By how much would government spending have to me to shift the aggregate demand curve rightward by $_40 billion? $ 4 billion How large a tax cut would be needed to achieve the same increase in aggregate demand? $ billion. Determine one possible combination of government spending increases and tax increases that would accompish the same goal without changing me amount or outstanding debt. Increase spend by $ billion increase taxes by $ billion

Explanation / Answer

Answer)

a.) In this problem, the government spending multiplier is 1/0.1 or 10 so, the required increase in government spending = $4 billion.

For the tax cut question, since tax multiplier is 0.9/0.1 = 9, so the required cut in taxes = $4.44 billion.

b.)  to finance this, government spending should increase by $40 billion and we raise taxes by an equivalent amount to ensure the level of outstanding debt does not change. That is, we also increase taxes by $40 billion. This results in a decrease in aggregate demand of $360 billion ( = -9 (tax multiplier) x $40 billion = -$360 billion (decline in AD)).

Combining the two effects above, we have an increase in aggregate demand of $40 billion (= $400 (increase from government spending) - $360 (decrease from increase in taxes)). This increase was achieved without increasing the debt.

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