Question

4. Suppose that investment demand increases by $100. Assume that households have a marginal propensity to consume of 80 percent. Compute the first three rounds of multiplier effects as follows:

a) What are the first cycle changes in spending? Total cumulative change equals?

b) What are the second cycle changes in spending? Total cumulative change equals?

c) What are the third cycle changes in spending? Total cumulative change equals?  

5. If a balanced budget government passes a new fiscal stimulus or restraint, it can lead to a deficit or surplus. In order to avoid an imbalance, how much of a tax hike or tax cut would be required? In the event of an extra $50 Billion of government purchases, $30 Billion of transfer payments, what should be the offsetting tax package?

4. Suppose that investment demand increases by $100. Assume that households have a marginal propensity to consume of 80 percent. Compute the first three rounds of multiplier effects as follows: a) What are the first cycle changes in spending? Total cumulative change equals? b) What are the second cycle changes in spending? Total cumulative change equals? c) What are the third cycle changes in spending? Total cumulative change equals?   5. If a balanced budget government passes a new fiscal stimulus or restraint, it can lead to a deficit or surplus. In order to avoid an imbalance, how much of a tax hike or tax cut would be required? In the event of an extra $50 Billion of government purchases, $30 Billion of transfer payments, what should be the offsetting tax packaing pleas answer them by typing

Answer 1

ANSWER:

4.

Marginal propensity is consume is 80% which means with 1 dollar increase in income, there is 0.80 dollar increase in the consumtion.

So when investment increases by $100, the houshlds will earn $100 as income, out of which they will spend $80 based on MPS. So first cycle will change in spending will be $80 and cumulative change will be equal to $180 ($100 + $80)

This $80 spending becomes incomes of others, which other will spend $64 based on MPS of 0.80 multiplied with income $80. Then So second cycle will change in spending will be $64 and cumulative change will be equal to $244 ($100 + $80+$64.)

This $64 spending becomes incomes of others, which other will spend $51.2 based on MPS of 0.80 multiplied with income $64. Then So third cycle will change in spending will be $51.2 and cumulative change will be equal to $2952 ($100 + $80+$64+$512.)

a) first cycle change in spending = 0.2*100 = 20. total commutative = 20

b) second cycle changes in spending = 0.2*0.2*100 = 4. total commutative = 24

c) third cycle changes in spending = 0.2*0.2*100= 0.8. total commutative = 24.8