In the economic of Zip, the marginal propensity to consume is 0.8. Government ex
ID: 1250900 • Letter: I
Question
In the economic of Zip, the marginal propensity to consume is 0.8. Government expenditures on goods and services are 50 billion, and taxes are 60 billion. Zip has no exports and no imports.1. the government increases its expenditures on goods and services to 60 billion. calculate the final change in aggregate demand as a result of this increase in government expenditures.
2. the government increases taxes to 70 billion. calculate the final chage in aggregate demand as a result of this increase in taxes.
3. the government simultaneously increases both its expenditures on goods and services and taxes by 10 billion. what is the net change in aggregate demand? why does aggregate demand increase?
Explanation / Answer
1. ?AD = 10 billion divided by 1-0.8 = 10 bill/0.2 = 50 billion increase in AD. 2. ?AD = -10 billion times (MPC/(1-MPC)) = -10 bill times (0.8/0.2) = 40 billion decrease in AD. 3. The net change in AD is 50 billion minus 40 billion = 10 billion increase in AD. AD increases because the government expenditure multiplier (GEM) is greater than the tax increase multiplier (TIM), since the marginal propensity to consume is less than 1. (GEM = 1/MPS) (TIM = MPC/MPS) According to Keynesian Economics, government spending is a greater stimulus than tax cuts.