Question

1. The Federal Government distributed a recovery relief fund to all households with $600 for all individuals filing and $1,200 for all households filing jointly and $500 for each children in each household. This was part of the $2.2 Trillion stimulus package under CARES Act of March 2020 that also included employee job protection plan for small business owners and restaurants, travel related businesses, unemployment insurances and households with no taxes filed. What would be the overall impact on AD of this recovery relief fund caused by COVID- 19 public health crisis and its effect on change in real GDP? Assume that the Marginal Propensity to Consume (MPC) for all American consumers is 0.8 in March 2020. Explain your answer briefly as well in your own words. Make sure you use your understanding of the concept of expenditure multiplier in estimating this problem.

2. Trump’s imposition of $260 billion tariff in the Month of May 2019 (taxes on imports to the US Market) on Chinese exports to the US has caused a global tension in financial markets and related business activities. In retaliation of Trump’s tariff, China also imposed almost similar amount of tariff on US exports to China about $200 billon. In response to this trade war between the US and China, the US stock price indices of the Wall Street plummeted in May and June 2019. Th stock market in Shanghai in China also crashed at the same time. The data on new job for the US economy in May showed a very slow rate of job creation at the same time. Given this scenario from the US-China trade war and given your knowledge on macro model of AD an AS, do you think the the retaliation of China in response to Trump’s Tariff would have a negative impact on the US economy in near future? Give your reason in your opinion as to why or why not the case.

Answer 1

1. Given total stimulus package - $2.2 Trillion

The divison of the stimulus is not important here in the context of our question because we are going to see the impact of the total stimulus on output.

To understand the impact of the stimulus lets recall what the expenditure multiplier is. The expenditure multiplier is defined as the change in output caused due to a change in aggregate expenditure. The mechanism works through the mpc. The way it works is that this stimulus package raises output by the amount of the stimulus in the initial period. Following this initial increase in output (income), consumptions rise in consequent periods through the mpc causing a multiplier effect. Mathematically multiplier is given in terms of mpc.

Multiplier (M) = 1/1-mpc = change in output (dY)/change in expenditure(dE) (by definition).

M = 1/1-0.8 = 1/0.2 = 5 = dY/dE

Given increase in expenditure (dE) = $2.2T

Therefore, 5 = dY/2.2T

or, dY = 2.2T*5 = $11Trillion

Thus a stimulus of $2.2trillion results in a rise in real gdp by $11trillion.