1) Suppose in a simple closed economy, the marginal propensity to consume is 0.8
ID: 1125417 • Letter: 1
Question
1) Suppose in a simple closed economy, the marginal propensity to consume is 0.80. The government has passed a balanced budget amendment. The economy goes into a recession, so the government increases government spending by $100 million to expand the economy (The balanced budget amendment requires the government to also raise taxes by $100 million). Calculate the change in output from this policy Explain your answer? 2) Describe the three roles of money. 3) Describe how a Central Bank open market purchase leads to a sequence of loans and deposits and thus money supply.Explanation / Answer
(1)
Spending multiplier = 1 / (1 - MPC) = 1 / (1 - 0.8) = 1/ 0.2 = 5. Therefore,
As government increases spending by $1, output increases by $5.
As government increases spending by $100 million, output increases by ($100 million x 5) = $500 million
Tax multiplier = - MPC / (1- MPC) = - 0.8 / 0.2 = - 4. Therefore,
As tax increases by $1, output decreases by $4.
As tax increases by $100 million, output decreases by ($100 million x 4) = $400 million
Net increase in output = $(500 - 400) million = $100 million
NOTE: As per Chegg answering policy, 1st question is answered.
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