In 2018, economists forecast the U.S. MPS will be .20 Estimate the maximum overa
ID: 1120848 • Letter: I
Question
In 2018, economists forecast the U.S. MPS will be .20 Estimate the maximum overall total effect on national income of the following two changes in fiscal policy: a) A decrease in govt spending of $80 billion and a decrease in taxes of $120 billion, If tax cut really happens and Congress and the President agree! If fiscal policy is unchanged but GPDI from businesses increases as below, what will be the maximum impact on national income? (Hint: the expenditure multiplier also applies to changes in GPDI by business) b) An increase in planned business investment spending (GPDI) of $60 billion without any change in fiscal policy. c) What are some reasons why the maximum multiplier efeect might not happen in the U S? HW due the night before class at the latest. Please email me your answers and all the calculations! Thanks!Explanation / Answer
A) A decrease in government spending by $80 billion and a decrease in taxes by $120 billion will have a net effect of an increase in disposable income by $40 billion. Because the MPS in the economy is going to be 0.20 the MPC will be 0.80 (MPC + MPS = 1) and the multiplier value will be (k = 1 / MPS) 1.25.
The economy will see an increase in the national income by $50 billion, that is $40 billion (net increase because of the tax cut) + $8 billion (multiplier effect).
B) If the Fiscal policy didn't change the net increase in the economy will be $60 Billion GDPI. This could lead to an increase of ($60 x 1.25) $75 billion in the economy.
c) The maximum multiplier effect happens when the household spends all their income on consumption and didn't save any amount. In the US economy, the households are saving 0.20 or 20% of their income and spending only the rest of 80%. Savings are considered leakage from the economy which is preventing the maximum multiplier in the US.
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