Question

In: Economics

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 $1,000 tax cut generate a smaller multiplier effect than
a $1,000 increase in government purchases?

Expert Solution

(a) Following are the three fiscal policy options to close the recessionary gap.

Increase government spending
decrease taxes
increase transfer payments.

(b) MPC = 0.75

Government spending multiplier = 1 / (1 - MPC) = 1 / (1-0.75) = 1 /0.25 = 4

Government increases purchases by $1000

Government spending multiplier = (change in real GDP / change in government spending)

=> 4 = (change in real GDP / $1000)

=> change in real GDP = 4 *$1000

=> change in real GDP = $4000.

Hence, the real GDP will increase by $4000 due to increase in government purchases by $1000.

------------------------------

Tax multiplier = -MPC / (1-MPC) = -0.75 / (1-0.75) = -0.75 / 0.25 = -3

Tax decreases by $1000.

Tax multiplier = (change in real GDP / change in taxes)

=> -3 = (change in real GDP / (-$1000))

=> change in real GDP = -3 *(-$1000)

=> change in real GDP = $3000

Hence, the real GDP will increase by $3000 due to decrease in taxes by $1000.

A $1,000 tax cut generate a smaller multiplier effect than
a $1,000 increase in government purchases because all amount of government spending increase is used in economy but household saves some part of their tax cut (so not all the portion of tax cut is used in the economy). Therefore, the increase in real GDP through tax cut is smaller than the increase in real GDP through increase in government spending.

Rahul Sunny answered 2 years ago

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

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

2. Fiscal Policy options to address a recessionary gap: Suppose the economy’s MPC is .75 or...

2. Fiscal Policy options to address a recessionary gap: Suppose the economy’s MPC is .75 or 3/4. A. If the government increases spending by $60 billion, what will the cumulative increase in AD be equal to? B. If the government decreases taxes by $60 billion, what will the cumulative increase in AD be equal to?

1.Outline how counter cyclical fiscal policy and balanced budget fiscal policy would close a recessionary gap....

1.Outline how counter cyclical fiscal policy and balanced budget fiscal policy would close a recessionary gap. Be specific on goals, how each theory would achieve those goals, how they would close the gap, and potential negative effects. 2.According to monetary policy, explain how the Bank of Canada would react to a recession. Be specific on goals, how they would achieve those goals, how they would close the gap, and potential negative effects. 3.Please describe how the PPC curve represents scarcity,...

The economy is in a recessionary gap. a) Describe the appropriate monetary policy and the steps...

The economy is in a recessionary gap. a) Describe the appropriate monetary policy and the steps the Bank of Canada takes. b) Draw the AS-AD model, starting in a recessionary gap. Show the effect of the appropriate monetary policy on the diagram. What happens to real GDP, unemployment, and inflation?

How does Congress and President use fiscal policy to fight a recessionary gap or inflationary gap?...

How does Congress and President use fiscal policy to fight a recessionary gap or inflationary gap? Why the deficits are good in the short run if the economy is in a recession? What’s the effect of crowding out on aggregate demand? What’s the effect of government borrowings on interest rates and investment? What’s the negative effect of automatic stabilizers?

Outline how counter cyclical fiscal policy and balanced budget fiscal policy would close a recessionary gap,...

Outline how counter cyclical fiscal policy and balanced budget fiscal policy would close a recessionary gap, explain： 1.How each theory would achieve those goals 2.How they would close the gap, 3.What's the potential negative effects. According to monetary policy, explain： 1.how the Bank of Canada would react to a recession 2.how they would achieve those goals 3.how they would close the gap 4.what's the potential negative effects

Outline how counter cyclical fiscal policy and balanced budget fiscal policy would close a recessionary gap....

Outline how counter cyclical fiscal policy and balanced budget fiscal policy would close a recessionary gap. Be specific on goals, how each theory would achieve those goals, how they would close the gap, and potential negative effects.

39. if we use the appropriate fiscal policy in a recessionary gap, which will happen? a....

39. if we use the appropriate fiscal policy in a recessionary gap, which will happen? a. the unemployment rate will rise b. wages will fall c. taxes will increase d. the government deficit rises 40. if you read a news report that says "The Fed is raising interest rates." What is the Federal Reserve actually doing a. decreasing the money supply b. reducing reserve requirements c. it is actually lowering interest rates d. increasing the money supply

Discuss what fiscal policy is and how it can be used to close a recessionary gap...

Discuss what fiscal policy is and how it can be used to close a recessionary gap or an inflationary gap.