Assume that a hypothetical economy with an MPC of 0.9 is experiencing severe rec

Question

Assume that a hypothetical economy with an MPC of 0.9 is experiencing severe recession Instructions: In part a, round your answers to 2 decimal places. Enter positive numbers. In part b, enter your answers as whole numbers. a. By how much would government spending have to rise to shift the aggregate demand curve rightward by $50 billion? $ billion How large a tax cut would be needed to achieve the same increase in aggregate demand?$ billion. b. Determine one possible combination of government spending increases and tax increases that would accomplish the same goal without changing the amount of outstanding debt. Increase spending by $ ] billion. Increase taxes by $ billion.

Explanation / Answer

Mpc=0.9 which means multiplier=1/1-mpc=1/1-0.9=10

Thus change in AD=change in income=multiplier*change in G

50=multiplier*change in G

Change in G=50/10=5

Tax multiplier=-MPC/1-MPC=-0.9/0.1=9

Thus change in Y=tax multiplier*tax

50=9tax

Change in tax=50/9=5.5555

B)10change in G -9 increase in tax=50

Say Tax increases by 50billion then G should also increase by 50billion. Both will lead to total net increase in income by 50 units. This is also known as fiscal drag.

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