Question

Assuming the AD shortfall = $2235B and MPC = .65, complete the questions below. Please round to at least 2 decimal places. a. (10 pts) Given the situation in a, if government spending increases by $782B, calculate the impact to aggregate demand. Illustrate this scenario on the appropriate graph. QF and the shift that occurs must be included on the graph. Is there a GDP gap? If so, what type? b. (10 pts) Given the situation in a, calculate what would happen if the government cut taxes by $782B. Illustrate this scenario on a separate graph. QF and the shift that occurs must be included on the graph. Is there a GDP gap? If so, what type? c. (5 pts) Which type of government intervention (from scenarios A & B ABOVE) gets us closer to full employment output?

Answer 1

a. Government Expenditure mUltiplier = dY/dG = 1/ 1- MPC

dY = (1/1-0.65) x 782 = 2234.2 Increase in G led to increase in aggregate demand and recovered the AD shortfall. Noew AD will shift to right and will intersect full employment level real output.

GDP gap was earlier and that was of the inflationary type as AD was less than potential output.

b. dY/dt = -MPC/1-MPC

dY = (-0.65 / 0.35) x 782 = -1452.28

Increase in taxation will decrease AD by 1452.28. AD curve will shift to left.

GDP gap is there and that is inflationary type as AD is less than potential output.

c. Scenario A gets us closer to full employment.