Question

An economy is operating with output $400 billion below its natural level, and fiscal policymakers want to close this recessionary gap. the central bank agrees to adjust the money supply to hold the interest rate constant, so there is no crowding out. the marginal propensity to consume is , and the price level is completely fixed in the short run. to close the recessionary gap, the government would need to spending by $ billion.

Answer 1

To close the recessionary gap, the government would need to increase spending by $80 billion.

Step-by-step explanation:

In order to close the recessionary gap, the government would need to increase spending. The amount of increase in spending can be calculated using the formula:

Change in GDP = Multiplier x Change in Government Spending

Given that the economy is operating $400 billion below its natural level, we can use the multiplier to determine the change in government spending. The multiplier is calculated as:

Multiplier = 1 / (1 - Marginal Propensity to Consume)

Substituting the given marginal propensity to consume, we get:

Multiplier = 1 / (1 - 0.8) = 5

To close the recessionary gap of $400 billion, the government would need to increase spending by $80 billion.

Answer 2

To close the recessionary gap, the government need to increase spending by 80 Billion Dollars. If the central bank agrees to adjust the money supply to hold the interest rate constant, so there is no crowding out. the marginal propensity to consume is 4/5 , and the price level is completely fixed in the short run.