Lesson 8 - Chapter 13 - Question PDF

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1. Assume that a hypothetical economy with an MPC of .8 is experiencing severe recession. By how much would government spending have to increase to shift the aggregate demand curve rightward by $25 billion? How large a tax cut would be needed to achieve this same increase in aggregate demand? Why th...

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Emily Kilker ECON 202 D01 Lesson 8 – Chapter 13 1. Assume that a hypothetical economy with an MPC of .8 is experiencing severe recession. By how much would government spending have to increase to shift the aggregate demand curve rightward by $25 billion? How large a tax cut would be needed to achieve this same increase in aggregate demand? Why the difference? Determine one possible combination of government spending increase and tax decrease that would accomplish the same goal. Show your complete work to explain each part in this question. Multiplier = 1/1-MPC = 1/1-0.8 = 1/0.2 = 5 Government Spending = Demand / Multiplier = 25/5 = $5 billion Government spending would have to increase by $5 billion to shift the aggregate demand curve rightward by $25 billion. C = MPC x T = 0.8 x T Consumption = Government Spending 0.8 T = 5 T = 5/0.8 = $6.25 billion A tax cut of $6.25 billion would be needed to achieve this same increase in aggregate demand. Initial spending of $5 billion is still required but only .8 (MPC) of the tax cut will be spent. Part of the tax reduction ($1.25 billion) is saved, not spent. The combination of a $1 billion increase in government spending and a $5 billion tax cut would accomplish the same goal....