Question

1. Refer to columns 1 and 6 in the table. Incorporate government into the table by assuming that it plans to tax and spend $20 billion at each possible level of GDP. Also assume that the tax is a personal tax and that government spending does not induce a shift in the private aggregate expenditures schedule. What is the change in equilibrium GDP caused by the addition of government?

2. (6) Aggregates, Private Open Economy, Billions	(5) Net Exports, Billions	(4) Imports, Billions	(3) Exports, Billions	(2) Aggregate Expenditures, Private Closed Economy, Billions	(1) Real Domestic output (GDP = DI), Billions
   $_________	$_________	$30	20$	$240	$200
   _________	_________	30	20	280	250
   _________	_________	30	20	320	300
   _________	_________	30	20	360	350
   _________	_________	30	20	400	400
   _________	_________	30	20	440	450
   _________	_________	30	20	480	500
   _________	_________	30	20	520	550

Answer 1

Ans: $20 billion

Explanation:

Here, MPC = Change in aggregate ecpenditue, private closed / Chnage in GDP = 40 / 50 = 0.8

Multiplier = 1 / (1 - MPC) = 1 / (1 - 0.8) = 5

Before Government expenditure is added, private sector equilibrium in open economy is $350. The addition of $20 billion of government expenditures and $20 billion of personal taxes increases equilibrium GDP from $350 to $370 billion.

This change in government expenditure is subject to the multiplier effect. Thus, the increase in Government spending will lead to an increase in the equilibrium GDP by $100 billion.(i.e., $20 billion * 5).

On the other hand, the $20 billion increase in Taxes reduces consumption by $16 billion (i.e., 0.8 * $20 billion) initially. This $16 billion decline in consumption will lead to a decrease in equilibrium GDP by $80 billion (i.e., $16 billion * 5).

The net change in GDP = $100 billion - $80 billion = $20 billion increase in equilibrium GDP.