1. In the second half of 2020, economists predicted that in the absence of a new fiscal stimulus package, concerns about possibility of infection and loss of income due to the COVID-19 pandemic would reduce household spending on good and services produced in the US by about $235 billion in 2021. At the end of 2020, the US government implemented a $120 billion cash transfer program by delivering $600 tax-free stimulus checks to 200 million Americans. For the purposes of this exercise, please ignore the other components of the actual stimulus package that was signed into law at the end of 2020. Assume that the stimulus package has no impact on other government expenditure, investment, or exports of the US economy. Also, assume that households start to spend their stimulus transfers in 2021 and for every dollar of increase in their disposable income (earnings net of taxes), they spend $0.50 on goods and services and save the rest. Finally, assume that for every dollar of spending, the US imports $0.20 worth of goods and services and the rest, $0.80, is spent on U.S. products.

(a)What will be the direct impact of the stimulus transfer on the total private spending in 2021? Please show/explain the logic of your calculations, in addition to the final answer. [4]

Answer:

(b)What will be the direct impact of the stimulus transfer on U.S. imports? Please show/explain the logic of your calculations, in addition to the final answer.[4]

Answer: .

(c)What will be the direct impact of the stimulus transfer on the total private spending on U.S. products? Please show/explain the logic of your calculations, in addition to the final answer.[4]

Answer:

(d)The increased amount of spending on U.S. products that you calculated in part (c) will be earned by American households, which will induce a second-round of increase in consumption expenditure. If the average tax rate is 20 percent, what will be the increase in household disposable income (i.e., after-tax income) in that second round? Please show/explain the logic of your calculations, in addition to the final answer. [5]

Answer:

(e)The increase in disposable income in the second round will lead to additional spending. The part of this additional spending that will fall on domestic products in that round will generate further income for domestic firms and will entail a third round of effects, causing increased disposable income, spending, imports, etc. Similarly, there will be fourth, fifth, ... rounds of income and spending increase. The following table provides a method of organizing the information about these rounds, up to round 10 when the marginal increases become negligible compared to the initial stimulus.

Assume that in each round, the spending, import, and tax shares will remain the same as described above. Calculate the increases in the variables listed in the last 4 columns of Table 1 for each listed round. Note: You may want to complete these calculations in a spreadsheet (such as Microsoft Excel) and transfer them back to this document. Please do not submit a separate document for your calculations. [15]