1) If the tax multiplier is -1.5 and a $200 billion tax increase is implemented,
ID: 1207617 • Letter: 1
Question
1) If the tax multiplier is -1.5 and a $200 billion tax increase is implemented, what is the change in GDP, holding everything else constant? (Assume the price level stays constant.)
2) Suppose real GDP is currently $12.5 trillion and potential real GDP is $13 trillion. If the president and the Congress increased government purchases by $500 billion, what would be the result on the economy?
3) Suppose the federal budget deficit for the year was $100 billion and the economy was in a recession. If the economy had been at potential GDP, it is estimated that tax revenues would have been $60 billion higher and government spending on transfer payments $50 billion lower. Using these estimates, what was the cyclically adjusted budget deficit or surplus for the year?
4) How could the existence of an unemployment insurance system or other transfer programs have reduced the severity of the Great Depression?
Explanation / Answer
(1) The tax multiplier means that as tax is increased by $1, GDP decreases by $1.5.
As tax increases by $200 billion, GDP falls by $200 billion x 1.5 = $300 billion.
(2) An increase in government purchase of $500 billion will increase real GDP by $500 billion (assuming no multiplier effect takes place since MPC/Multiplier value is not given), and real GDP rises to $(12.5 + 0.5) = $13 trillion. So, real GDP equals potential GDP and recessionary gap is eliminated, and price level is restored to full-employment level of price.
NOTE: First 2 questions are answered.
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