Question

#2 In the following table, indicate the effect of each scenario on the aggregate demand curve.

Scenario Change in Aggregate Demand

Government spending increases.(Increases or Decrease)

The amount of taxes collected decreases. (Increases or Decreases)

#4

Why does a reduction in taxes have a smaller multiplier effect than an increase in government spending of an equal amount?

A tax cut directly injects zero new spending into the economy because the government has purchased no new goods and services.

An increase in government spending doubles initially because the government spends the entire tax revenue on new goods and services.

#5

Suppose you are an economic adviser to the president, and the economy needs a real GDP increase of $700 billion to reach full-employment equilibrium.

If the marginal propensity to consume (MPC) is 0.6 and you are a Keynesian, Congress must increase government spending by ................ billion to restore the economy to full employment.

Answer 1

Ans 2.)

. (a) As the government spending is a component of the AD So, Increase in government spending increases the aggregate demand.

The AD curve shifts towards the right.

(b) Decrease in tax collections leads to the decline in the aggregate demand as the governmemt has less revenue to spend on the goods and services.

The AD curve shifts towards the left.

Ans 4.) Option A

As a tax cut does not directly involves injection of money in the economy , whereas the increase in government spending includes injecting money into the economy for the purchase of goods and services which ledas to an increase in the aggregate denand.

Ans 5.) $280 billion

We first calculate the value of nultiplier.

Multiplier = 1 ÷ (1 - MPC)

As , MPC = 0.6

Multiplier = 1 ÷ (1 - 0.6) => 1/0.4 => 2.5

Totsl change in output = Multiplier × Initial spending ... eq(1)

Substituting the values in the eq(1) gives

700 = 2.5 × Initial spending

Initial spending = 700/2.5  

Initial spending = $280 billion