4. Assume the economy is in a recession. The government is weighing possible fis
ID: 1222866 • Letter: 4
Question
4.
Assume the economy is in a recession. The government is weighing possible fiscal policy options. It knows that the recessionary gap equals $500 billion. It also knows that the marginal propensity to consume equals 0.75. Finally, it knows that the AD shortfall is two times as large as the recessionary gap. Given this information, the government will need to spend ________ in order to entirely eliminate the recessionary gap.
$500 billion
$1 trillion
$250 billion
$100 billion
5. Assume the economy is in a recession. The government knows that the recessionary gap equals $500 billion. It also knows that the marginal propensity to save equals 0.25. Finally, it knows that the AD shortfall is four times as large as the recessionary gap. The government decides that it wants to try to stimulate the economy via tax cuts. It will need to spend approximately ________ in order to entirely eliminate the recessionary gap.
a.
$500 billion
b.
$2 trillion
c.
$1 trillion
d.
$666 billion
$500 billion
$1 trillion
$250 billion
$100 billion
Explanation / Answer
question No 4.
To close the recessionary gap we have to know the multiplier , MPC is given = 0.75
then multiplier is K = 1/MPS = 1/ (1-MPC)
= 1/(1- 0.75)
= 1/ 0.25
K = 4
government knows that AD is two time shortfall of recessionary gap. it means AD short fall
500 * 2 = 1000 billion
now multiplier is 4 so government need to increase its expenditure by
1000/4 = $250 billion
option C(3) is correct.
Question no 5.
government wants to meat the recessionary gap by tax cut .
tax multiplier is = MPC/(1-mpc) = 0.25/(1-0.25)
= 0.25/0.75 = 1/3
AD shortfall is 4 times of recessionary gap. = 4* 500 = $2000
government needs to spend = 2000*1/3 = 666 billion (approx)
option D(4) is correct.
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