Question

For each of the following fiscal policy proposals, determine whether the primary focus is on aggregate demand or aggregate supply or both.

a. A $1000 per person tax reduction

b. a 5% reduction in all tax rates

c. Pell grants, which are government subsidies for college education

d. government sponsored prizes for new scientific discovery

e. an increase in unemployment compensation

5) Fill in the blanks in the table below. Assume that the MPC is constant over everyone in the economy.

MPC	Spending multiplier	Change in Government Spending	Change in Income
	10	50
	2.5		-800
0.5		425
0.2			1200

Answer 1

4. a) Aggregate demand [A reduction in tax will increase in aggregate demand]

b) Both                               [A reduction in all tax will increase in aggregate demand as well as aggregate supply]

c) Aggregate supply           [An increase in government subsidy will lead to increase in aggregate supply]

d) Aggregate supply           [New scientific discovery will lead to increase in aggregate supply]

e) Both              [An increase in unemployment compensation will increase in aggregate demand as well as aggregate supply]

5)

Spending Multiplier = 1 / (1 - MPC)

1 - MPC = 1 / Spending Multiplier

MPC = 1 - (1 / Spending Multiplier)

MPC	Spending multiplier	Change in Government Spending	Change in Income
0.9	10	50	500 [i.e., 10 * 50]
0.6	2.5	-320 [i.e., -800 / 2.5]	-800
0.5	2 [i.e., 1 / (1 - 0.5]	425	850 [i.e., 2 * 425]
0.2	1.25 [i.e., 1 / (1 - 0.2]	960 [i.e., 1200 / 1.25]	1200