How much government spending needs to be increased to maintain full employment in the economy If...

How much government spending needs to be increased to maintain full employment in the economy If the economy was facing recessionary gap of $900 billions? Assume MPC is .9. How much tax cut should government give if they wanted to eliminate this recessionary gap through tax cut?

Solutions

Expert Solution

recessionary gap = 900 which mens Y = 900

MPC = 0.9

Y/G = 1/(1 - MPC )

900/G = 1/(1 - 0.9)

900/G = 1/0.1

900/G = 10

900 = 10G

G = 900/10 = 90

Therefore goverenment spending should be increasesd by $ 90 to maintain full employment in the economy

Now Y/T = - MPC/(1 - MPC)

900/T = - 0.9/(1 - 0.9)

900/T = - 0.9/0.1

900/T = - 9

900 = - 9T

T = - 900/9

= - 100

Thus government should give $100 tax cut to eliminate this recessionary gap

Rahul Sunny answered 1 year ago

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