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

A)okun's law states that each 1% cyclical unemployment ,leads to 2% loss of gdp.

Cyclical unemployment= actual unemployment- natural rate of Unemployment

Because natural rate of unemployment=5%

So , Cyclical unemployment= 8.8-5=3.8

Loss of gdp=3.8*2=7.6%

Loss of gdp=7.6*8000/100=608

Government spending multiplier=1/(1-mpc)=1/(1-0.8)=1/0.2=5

So required government spending increase to eliminate gdp loss=608/5=121.6

Tax cut multiplier=mpc/(1-mpc)=0.8/(1-0.8)=0.8/0.2=4

Required tax cut=608/4=152

B) change in consumption=4000

Change in income= 46,000-40,000=6000

MPC= change in consumption/ change in income=4000/6000=2/3=0.67

MPS=1-MPC=1-2/3=1/3=0.33

Multiplier= 1/ MPS=1/(1/3)=3

3) change in income= change in G * multiplier

Change in G=500

So,

Change in income= 500*5=2500

New Equilibrium income= 5000+2500=7500