Question

Suppose the consumption function is c = $500 billion + 0.9y and the government wants to stimulate the economy. by how much will aggregate demand at current prices shift initially (before multiplier effects) with

Answer 1

To stimulate the economy and reach the full employment GDP, the government can increase government spending using the multiplier effect. The multiplier effect allows an initial increase in government spending to have a larger impact on the equilibrium level of real GDP. In this case, the government would need to increase spending by $1000 billion.

Step-by-step explanation:

The government can use the multiplier effect to stimulate the economy by increasing government spending. In this case, the government wants to increase the aggregate demand to reach the full employment GDP. To find out by how much the government spending needs to be increased, we need to calculate the multiplier effect.

The multiplier effect formula is given by:

Multiplier = 1 / (1 - MPC)

Where MPC is the marginal propensity to consume.

In this case, the consumption function is c = $500 billion + 0.9y, which means that the marginal propensity to consume (MPC) is 0.9.

So, the multiplier can be calculated as:

Multiplier = 1 / (1 - 0.9) = 1 / 0.1 = 10

This means that for every $1 increase in government spending, the aggregate demand will increase by $10. To reach the full employment GDP of $800, the government spending needs to be increased by:

Government Spending Increase = ($800 - $700) * 10 = $100 * 10 = $1000 billion

Answer 2

Answer: Spending Multiplier=1/1-0.9=10 a. the GDP will increase= 10x50=$500 billion Tax multiplier= 0.9/1-0.9=9 b. the GDP will increase= 50 x 9=$450billion c. nothing will happen.Transfer payment will not affect GDP.