Which of the following would be the best fiscal policy to put the economy on its...

Which of the following would be the best fiscal policy to put the economy on its long run equilibrium?

Marginal Propensity to save	Full employment GDP	Current GDP
.2	25 Billion	15 Billion

Increase of 2 billion in government spending

Increase of 10 Billion in government spending

Increase of 4 billion in tax breaks

Increase of 5 billion in government spending

The government decides to increase government spending in an attempt to help move the economy into its long run equilibrium: which of the following should be a concern?

Crowding out

Liquidity trap

Deflation, leading to a recession

Stagflation

Expert Solution

Q1
Answer
Option 1
Increase of 2 billion in government spending

Multiplier=1/MPS
=1/0.2
=5
the required change in government spending =output gap/multiplier
output gap=Full employment GDP-Current GDP=25-15=10 billion
the required change in government spending =10/5=2 billion
============
Q2
Option 1
Crowding out

An increase in government spending increases the price level and that increases money demand which increases the interest rate. The increase in interest rate increases funding from abroad but the domestic investments decrease as the borrowing money costs more and decreases the effect of an increase in government spending on the GDP.

Rahul Sunny answered 2 years ago

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