Suppose that the federal government has identified a recessionary gap of $250 billion. If they decide...

Suppose that the federal government has identified a recessionary gap of $250 billion. If they decide to use fiscal policy, what type of fiscal policy should they adopt? Calculate both of their options (and be specific about direction) considering that the MPC = 0.75.

Solutions

Expert Solution

In case of recessionary gap the Federal government uses the expansionary fiscal policy. It means that it will either increase government spending or decrease taxes in order to increase aggregate demand and output such that the recessionary gap is eliminated.

Government spending multiplier= 1/(1–MPC)= 1/(1–0.75)= 4

Tax Multiplier= –MPC/(1–MPC)= –3.

Required Increase in Output= Recessionary Gap= $250 billion

Change in Governnment spending Required to eliminate Recessionary Gap= required increase in output /government spending multiplier

Change in government spending required to eliminate recessionary gap= $250/4= $62.5 billion

So in order to eliminate the recessionary gap the government spending must be increased by $62.5 billion

Change in taxes required to eliminate recessionary gap= required increase in output/tax multiplier

Change in taxes required to eliminate recessionary gap= 250/–3= –$83.33 billion

So in order to eliminate the recessionary gap the taxes should be Decreased by $83.33 billion.

Rahul Sunny answered 3 months ago

Next > < Previous

Related Solutions

Question 1: Fiscal Policy Suppose the economy is in a recessionary gap, and the government reponds...

Question 1: Fiscal Policy Suppose the economy is in a recessionary gap, and the government reponds by conducting an expansionary fiscal policy. a. What are the three fiscal policy options available to the government in its attempt to close the recessionary gap? b. Suppose the marginal propensity to consume is 0.75. Calculate the effect of a $1,000 increase in government purchases on real GDP, and then calculate the effect of a $1,000 tax cut on real GDP. Why does a...

Now, assume that the Fed has identified a recessionary gap. What type of monetary policy would you...

Now, assume that the Fed has identified a recessionary gap. What type of monetary policy would you recommend? Be specific as to the three tools that the Fed could use to implement this policy.

6. An economy is facing a recessionary gap and the Federal Reserve decides to engage in...

6. An economy is facing a recessionary gap and the Federal Reserve decides to engage in expansionary monetary policy. What are the three tools that the Federal Reserve can use to get the money supply to grow and what direction should each take?

how fiscal policy such as changing government expenditure may close recessionary gap/ inflationary gap.

Marginal Propensity to consume is .68 when a recessionary gap of 200 Billion exist. Calculate the...

Marginal Propensity to consume is .68 when a recessionary gap of 200 Billion exist. Calculate the amount of government spending, ceteris paribus, necessary to remove the gap. Calculate the amount of a tax cut, ceteris paribus, necessary to remove the recessionary gap. Contrast the approach a supply side economist would use to remove the recessionary gap in question 3.

Suppose the economy is experiencing a recessionary output gap. What has happened to planned aggregate expenditure?...

Suppose the economy is experiencing a recessionary output gap. What has happened to planned aggregate expenditure? What might have caused this change?

To close a recessionary gap with discretionary fiscal policy, the government wouldtaxes, and the____curve would shift...

To close a recessionary gap with discretionary fiscal policy, the government would__________taxes, and the______________curve would shift to the _________. Select one: a. increase, supply, left b. decrease, supply, right c. decrease, demand, right

Suppose an economy is experiencing higher inflation rate as well as a recessionary gap. Using the...

Suppose an economy is experiencing higher inflation rate as well as a recessionary gap. Using the policy reaction function, explain whether the Reserve bank will increase or decrease the interest rate?

Suppose the economy is experiencing a recessionary gap of $0.5 trillion. The marginal propensity to consumer...

Suppose the economy is experiencing a recessionary gap of $0.5 trillion. The marginal propensity to consumer is MPC = 0.2. To mitigate or close the gap, the fiscal government need to choose between two options: increase government spending G or decrease taxes. Fill in the gaps with numerical answers unless otherwise instructed. Round your answers to one decimal place (for example, 1.25 ~ 1.3). The value of the spending multiplier is at most equal to . The value of the...

Describe a policy measure the government can use to close a recessionary gap. 2. Illustrate your...

Describe a policy measure the government can use to close a recessionary gap. 2. Illustrate your response to part 1 in a graph. 3. Describe a policy measure the government can use to close an inflationary gap. 4. Illustrate your response to part 3 in a graph.

Subjects