Question

In: Economics

24. Consider an economy that implements an expansionary fiscal policy of increased government spending by $X...

24.

Consider an economy that implements an expansionary fiscal policy of increased government spending by $X amount. Which of the following by itself would tend to make the change in aggregate demand different from $X?

a. both the multiplier effect and the crowding-out effect

b. the multiplier effect, but not the crowding-out effect

c. the crowding-out effect, but not the multiplier effect

d. neither the crowding out effect nor the multiplier effect

25.

If the multiplier is 2 and if there is no crowding-out effect, then a $60 billion increase in government expenditures causes aggregate demand to:

increase by $250 billion.

increase by $120 billion.

increase by $360 billion.

None of the above are correct.

27.

Consider an economy that spends 60 percent of every additional dollar of income earned. Assume there are no crowding out or investment accelerator effects. If the government increases expenditures by $200 billion, then by how much does aggregate demand shift to the right? If the government decreases taxes by $200 billion, then by how much does aggregate demand shift to the right?

$300 billion and $180 billion

$300 billion and $300 billion

$500 billion and $300 billion

$500 billion and $500 billion

Solutions

Expert Solution

Answer 24 : a. both the multiplier effect and the crowding-out effect

When govt spending increases by $X then the multiplier effect leads to a rise in GDP, but due to rise in GDP because of rise in govt spending interest rate rises and there is a slight fall in investment which leads to a fall in GDP, so bith the effects by itself would tend to make the change in aggregate demand different from $X.

..

Answer 25: increase by $120 billion

change in income/output = multiplier * change in govt spending

we know that multiplier = 2 and change in govt spending = 60 billion

So a change in income/output = 2 * 60 billion = $120 billion

..

Answer 6: $500 billion and $300 billion

an economy that spends 60 percent of every additional dollar of income earned has an MPC = 0.6

government increases expenditures by $200 billion,

government multiplier = 1/ 1-MPC

government multiplier = 1/ 1-0.6 = 1/0.4 = 2.5

change in income/output = multiplier * change in govt spending

change in income/output = 2.5 * 200 = $500 billion

if the government decreases taxes by $200 billion

change in income/output = multiplier * change in taxes

tax multiplier = -MPC/ 1-MPC = -0.6/ 1-0.6 = -0.6/0.4 = -1.5

change in income/output = -1.5 * -200 = $ 300 billion


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