Marginal Propensity to consume is .68 when a recessionary gap of 200 Billion exist. Calculate the...

Marginal Propensity to consume is .68 when a recessionary gap of 200 Billion exist. Calculate the amount of government spending, ceteris paribus, necessary to remove the gap. Calculate the amount of a tax cut, ceteris paribus, necessary to remove the recessionary gap.

Contrast the approach a supply side economist would use to remove the recessionary gap in question 3.

Expert Solution

MPC = 0.68

Spending Multiplier = [1 / (1 - MPC)] = [1 / (1 - 0.68)] = 3.125

Recessionary gap = $200 billion

Government spending should rise by = Recessionary gap / Spending Multiplier

= 200 / 3.125 = 64

To remove recessionary gpa of $200 billion, $64 billion spending should be raised.

Tax Multiplier = (MPC / MPS) where MPC + MPS = 1

MPS = 1 - 0.68 = 0.32

Tax Multiplier = 0.68 / 0.32 = 2.125

To remove recessionary gap of $200 billion, tax cut should be = Recessionary gap / Tax Multiplier

= 200 / 2.125 = 94.11

Government should reduce the cost of production for producers to raise the supply in the economy from AS to AS1 to remove recessionary gap equal to Y1 - Y0.

Rahul Sunny answered 2 years ago

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