Please answer all questions with detail and a proper explanation. Please show yo

Question

Please answer all questions with detail and a proper explanation. Please show your work.

Assume the economy has a GDP of $11,500 billion. The unemployment rate is at 7.3% and has been slowly rising for the last 6 months. Inflation was at 2.3% one year ago but has since dropped to near 0%. The MPC in the economy is .80 and the Natural Rate of Unemployment is 4.5%. The target rate for inflation is 2%.

a. What problem is the economy currently facing?

b. Is the problem serious enough that government should act to solve it?

c. If the government does decide to act, what size government expenditure would fix the problem

d. What size tax change would fix the problem?

e. Why would it be better for government to solve the problem using government purchases (part c above) rather than taxes (part d above) to solve the problem? f. Assuming that government does decide to use the tax policy, what could happen to cause the policy to be ineffective?

Explanation / Answer

A) there is a problem of rising unemployment. It is due to Phillips curve because Inflation was at 2.3% one year ago but has since dropped to near 0%.

B) yes because the difference between natural rate of unemployment and actual unemployment rate is not that much that is around 2.3% and inflation is also falling

C) there is a need to decrease unemployment rate to natural rate of unemployment i.e 4.5%  government should increase spending enough to increase the employment rate above the NAIRU

So 4.5% of GDP = 517.5 billion

D) tax should be increased by $ 517.5 billion

E) it is better to solve the problem using government purchases because it will increase government spending and further leads to increase in aggregate demand and national income and will also create more employment opportunities due to government spending.

F) people would decrease their consumption because their disposable income would fall due to increase in taxes. Hence, the aggregate demand of the economy would fall instead of rising

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