Question

What will happen to aggregate demand in totality when the government cuts taxes by $200 million and, at the same time, decreases government purchases by $200 million. Please assume an MPC of 0.8.

a. Aggregate demand will be unchanged as the two policies offset each other.

b. Aggregate demand will increase by $10 million.

c. Aggregate demand will increase by $200 million.

d. Aggregate demand will decrease by $20 million.

e. Aggregate demand will decrease by $200 million.

f. Aggregate demand will decrease by $1,800 million.

and

Assume that the United States uses 20 worker-hours to produce 1 computer and 5 worker-hours to produce 1 unit of food; assume that Japan uses 10 worker-hours to produce 1 computer and 30 worker-hours to produce 1 unit of food. Which of the following is true?

a. Japan has the comparative advantage in food production.

b. Japan has the absolute advantage in food production, but the comparative advantage for making computers.

c. Japan should specialize in food production and trade with the United States for computers.

d. The United States has the absolute and comparative advantage in food production.

e. The United States has the comparative advantage for making computers.

Answer 1

Answer
1.e. Aggregate demand will decrease by $200 million.

The Tax multiplier = MPC/(1-MPC)
The Expenditure multiplier = 1/(1-MPC)
Net multiplier = Tax - Expenditure multiplier
or MPC/(1-MPC) - 1/(1-MPC) = -1
200 x (-1) = -200 million

2 d. The United States has the absolute and comparative advantage in food production.
Cost of producing 1 computer America =20 worker hours or 4 units of food
Opportunity Cost Computer (America) = 4/1 = 4 units of food

Cost of producing 1 computer Japan = 10 worker hours or 1/3 units of food
Opportunity Cost Computer (Japan) = 1/3 units of food
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