Part II 1-The government economists in a small country have determined that the
ID: 1106194 • Letter: P
Question
Part II 1-The government economists in a small country have determined that the current equilibrium level of GDP at $350 billion is below the full employment GDP level of $410 billion. They further estimated a MPC of Q.60 for the households. They have proposed 3 actions the country's government can take to stabilize the economy. Use the info to ill in the blanks: 1- Increasing government purchases b 2- Increasing transfer payments by 3- Lowering taxes by 700 600 500 400 AEo AE2 280 0 100 200 300 400 500 600 700 Real GDP (dollars) 2-In the graph above, the current equilibrium is based on AEo (aggregate expenditures) a- Suppose AE decreases What will be the $ GDP at the new equilibrium b- Suppose AE increases. What will be $ AE at the new equilibrium? c- What is the value of simple spending multiplier?(show how you got your answer)Explanation / Answer
A)
Output gap = 410 - 350 = $60 bn
MPC = 0.6
1) Output gap = Government purchases (increase) x 1/(1 - MPC)
Government purchases (increase) = 0.4 x 60 = $24 bn
2) Output gap = Transfer payments (increase) x MPC/(1 - MPC)
Transfer payments (increase) = 0.4/0.6 x 60 = $40bn
3) Output gap = Taxes (decrease) x MPC/(1 - MPC)
Taxes (decrease) = 0.4/0.6 x 60 = $40bn
B)
a) AE decreases, GDP at the new equillibrium = $300
b) AE increases, AE at the new equillibrium = $700
c) Increase in Y intercept by 80 (=280 - 200) causes the equillibrium GDP to rise by 200 (=700 - 500)
80/(1 - MPC) = 200
Multiplier = 1/(1 - MPC) = 200/80 = 2.5