5. Suppose that real GDP is currently $17.1 trillion, potential GDP is $17.4 tri

Question

5. Suppose that real GDP is currently $17.1 trillion, potential GDP is $17.4 trillion, the government purchases multiplier is 2, and the tax multiplier is-1.6. .Holding other factors constant, by how much will government purchases need to be increased to bring the economy to equilibrium at potential GDP? .Holding other factors constant, by how much will taxes need to be cut to bring the economy to equilibrium at potential GDP? What is an example of a combination of increase in government purchases and tax cuts that would have the desired effect of bringing the economy to equilibrium at potential GDP?

Explanation / Answer

Real GDP =$17.1 trillion

Potential GDP = $ 17.4 trillion

Government purchases multiplier =2

Tax multiplier = -1.6

(a) Holding other factors constant , then by how much will government purchases need to be increased to bring the economy to equilibrium at potential GDP = $(17.4 - 17.1) / 2

=$ 0.3/2 = $ 0.15 trillion

(b) Holding other factors constant , then by how much will taxes need to be cut to bring the economy to equilibrium at potential GDP = $(17.4 - 17.1)/-1.6

= $- 0.3/1.6 = $- 0.1875 trillion.

(c) One example is to increase government purchases by $ (0.15/2) = $0.075trillion and tax cuts by $(0.1875/2) = $ 0.09375 trillion that would have the desired effect of bringing the economy to equilibrium at potential GDP.

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