Question

6

Suppose a closed economy with no government spending or taxing initially. Suppose also that intended investment is equal to 200 and the aggregate consumption function is given by C = 200 + 0.50Y. And suppose that, if at full employment, the economy would produce an output and income of 3200

By how much would the government need to raise spending (G) to bring the economy to full employment?

7

Suppose a closed economy with no government spending which in equilibrium is producing an output and income of 2000. Suppose also that the marginal propensity to consume is 0.80, and that, if at full employment, the economy would produce an output and income of 3650

By how much would the government need to cut taxes (T) to bring the economy to full employment?

Answer 1

6. The government would need to raise spending (G) of 1200 to bring the economy to full employment.

Explanation:

Actual level of income or output ;

Y = C + I = 200 + 0.5 Y + 200 = 0.5Y + 400

1- 0.5Y = 400

0.5Y = 400

Y = 400 / 0.5 = 800

Fulemployment level of income = 3200

Income or output gap = 3200 - 800 = 2400

Spending multiplier = 1/ ( 1- MPC ) = 1/ ( 1 - 0.50 ) = 1/0.50 = 2

Change in Income or output = Government spending * Spending multiplier  

2400 = Government spending * 2

Government spending = 2400 /2 = 1200

7.Ans: the government need to cut taxes (T) of 413  to bring the economy to full employment.

Explanation:

Actual income level of income = 2000

Fulemployment level of income = 3650

Income or output gap = 3650 - 2000 = 1650

Tax multiplier = -MPC / MPS = -0.80 / ( 1- MPC ) = -0.80 / 0.20 = -4

Change in Income or output = Tax amount   * Tax multiplier  

1650 = Tax amount *( -4 )

Tax amount = 1650 / -4 = -412.5 or -413