Question
A media report states: Firms cut back on investment spending causing a recession. Prior to the recession assume the economy of Keynesland was producing at
A media report states: "Firms cut back on investment spending causing a recession." Prior to the recession assume the economy of Keynesland was producing at its potential real GDP and the price level was stable. The decrease in IG created a negative GDP gap, actual real GDP is $100 billion below potential real GDP. Policymakers decide to use discretionary fiscal policyto increase aggregate demand.
POLICY OPTION 1: A change in government purchases.
Predict how much government purchases (G) would have to change in order to return the economy to its full-employment level of real GDP. Assume the economy's marginal propensity to consume or
MPC = 0.90 and that there is no crowding-out effect.
MUST SHOW THE FORMULA AND YOUR CACULATIONS FOR 1a - d
a. To close the recessionary gap government purchases must _____ by $_____ billion.
Formulas: Multiplier =
GDP = Multiplier x G
POLICY OPTION 2: A change in taxes.
Predict how much tax revenues would have to change in order to return the economy to its full-employment level of real GDP. The MPC = 0.90 and there is no crowding-out effect.
b. To close the recessionary gap consumption (C) must ______ by $______ billion.
Formula: GDP = Multiplier x C
To achieve this change in the level of consumption spending
c. tax revenues must ___________ by $______ billion
d. which will ______ disposable income by $_____ billion
Formula: MPC x Income = C
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