Suppose the government wants to increase interest rates to give an incentive to businesses to change how much they invest.

Suppose an economy is in full employment when income is $8,000 million. Currently, their income is $8,434 million. The spending multiplier is 2.8 and the tax multiplier is 2.0.

Suppose the government wants to increase interest rates to give an incentive to businesses to change how much they invest. How much will investments need to change for the economy to reach full employment?

Suppose the government decides to increase taxes. How much will taxes need to change for the economy to reach full employment?

Solutions

Expert Solution

Change in GDP required = Full employment income - Current income = 8000 - 8434 = -434 million

a. According to spending multiplier,
Change in GDP/Change in investment = 2.8
So, Change in investment = Change in GDP/2.8 = -434/2.8 = -155
So, investment needs to decrease by $155 million

b. Tax multiplier is always negative. So, tax multiplier = -2
According to tax multiplier,
Change in GDP/Change in tax = -2
So, Change in tax = Change in GDP/(-2) = -434/(-2) = 217
So, tax needs to increase by $217 million

Rahul Sunny answered 1 year ago

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