Question

1. Calculate GDP loss if equilibrium level of GDP is $8,000, unemployment rate 8.8%, and the MPC is 0.80. Hint: (Use Okun's law to calculate GDP loss)

a) How much money should the government spend to eliminate this GDP loss?

b) Calculate the tax cut needed to eliminate this GDP loss.

2. Calculate MPC, MPS and the Multiplier if consumption expenditure increases by $4,000 as a result of increase in income from $40,000 to $46,000.

3. Assume that initially G is $300 and equilibrium real GDP is $5000. If the multiplier is 5, what would be the new equilibrium level of GDP if Government expenditures increase to $500.

Answer 1

1.

a) According to Okun's Law mentioned as below:

Thus, the GDP loss is 1825.

b) To estimate the GDP loss, the tax cut should be as follows:

Thus, the taxes should fall by 456.25 to reduce the GDP gap.

2.

MPC + MPS = 1

MPC = 1-MPS

MPS = 1-MPC

Multiplier = 1/1-MPC

Consumption Expenditure increase : $4000

Income increase = $46000 - $40000 = $6000

So, MPC = $4000 / $6000 = 0.66

MPC = 0.66

MPS = 1-MPC = 1-0.66 = 0.34

MPS = 0.34

Multiplier = 1/1-MPC = 1 / (1-0.66)

= 1 / 0.34

Multiplier M = 2.94

3.

The change in real GDP is calculated as follows:

= 5*($500 - $300)

= $1000

The new equilibrium would be:

= $1000 + $5000

= $6000

The new equilibrium level GDP is $6000.