Suppose it was found that the mpc varied by income level in the following manner,

with lower income households spending a greater portion of every dollar of income

than higher income households.

Household income mpc Income/spending

multiplier

Tax multiplier

0-$30,000 0.9

$31,000 - 50,000 0.8

$51,000 - 80,000 0.75

$80,000 and above 0.6

a. Calculate the government spending and tax multipliers for each income bracket,

considered separately.

b. Suppose the government decided to use tax cuts to expand the economy, and

was debating whether to direct tax cuts to high income households or low

income households. Which choice would provide a greater stimulus? Thus,

which would do the least amount of damage to the government budget deficit to

achieve a given amount of stimulus?

(Note: Technically, while tax cuts can, by design of the policy, be targeted so that

their initial impact is on the incomes of a particular group, the feedback effects

represented by the multiplier probably in general depend on the economy-wide

average value of the mpc. We abstract from this issue in this question.)

The relationship between Chinaand the United States is often in the news.To refresh your memory, here are fourfacts about the Chinese economy:China manages its exchange rate with the dollar.China runs a trade surplus with the United States.The Chinese central bank owns a large number of U.S. Treasury bills.Individual Chinese residents are not free to invest their savings in foreign coun-tries as they would like.Any movement away from a managed exchange rate wouldprobably include a relaxation of these restrictions.Nowevaluatethefollowingclaimsbelowwiththreetofivesentencesforeach.You should also feel free to use graphs or equations where appropriate.Your goal isto discuss why the claim is true, partially true, or not true at all.

a.(5 points) "Cheap imports from China come a steep cost - lost jobs and lowerwages for American workers."

b. (5 points) "Over time, the Chinese government can maintain an unfair tradingrelationship with the United States by pegging its currency to the dollar at a lowlevel."

c.(5 points)"Inthelongrun,ifChinacontinuestopegitscurrencytothedollaratanabnormallylowvalue,itmayincurasignificantincreaseinitspricelevel."

d.(5 points) "The only way for the United States to close its bilateral tradedeficit with China is to either raise national savings in the U.S. or reduce investmentin new plant and equipment in the U.S."

e.(5 points) "Because China has a fixed exchange rate, it is unable to conductdiscretionary monetary policy."

1. Fiscal policy refers to ...

a. control of the money supply

b. decisions to alter market interest rates

c. government spending and taxation decisions

d. control of the producer price index

e. none of these

2. Which of the following is not a component of aggregate expenditure?

a. consumption

b. unsold inventories

c. intended investment

d. government spending

e. all of these are components of aggregate expenditure

3. Suppose in a simple economy with no foreign sector, the mpc is equal to 0.75. How

much government spending (G) would be needed to raise output by 100 million?

a. 25 million

b. 33.3 million

c. 75 million

d. 400 million

e. None of the above

4. Which of the following is not an example of a transfer payment?

a. Welfare payments to firms or individuals

b. Social Security payments

c. Unemployment compensation

d. A corporate tax cut

e. Payments of interest to holders of government bonds.