Question

If the MPC is 0.80 and the government increases spending on cancer research by $15 billion.(a) What is the value of the initial impact on real GDP? What is the value of the total impact on real GDP? What effect do you think a $50 billion increase in government spending will have on the economy?(b) Assume the MPC is 0.80 and policy makers have targeted real GDP to increase by $200 billion. By how much must taxes be reduced to achieve this goal?

Answer 1

(a) What is the value of the initial impact on real GDP? What is the value of the total impact on real GDP? What effect do you think a $50 billion increase in government spending will have on the economy?

The initial impact will be $15 billion.

The total impact should = $15 x [1 / (1 - 0.8)] = $15 x (1/0.2) = $15 x 5 = $75 billion.

If the government increased expending by $50, the total impact = $50 x 5 = $250 billion

(b) Assume the MPC is 0.80 and policy makers have targeted real GDP to increase by $200 billion. By how much must taxes be reduced to achieve this goal?

tax multiplier = 0.8 / (1 - 0.8) = 0.8 / 0.2 = 4

the government should decrease taxes by $200 / 4 = $50 billion