Question

If the mpc=0.8 and t=0.1, by how much will Y∗ increase if G increases by 50? How does automatic fiscal stabilization affect the economy?

Draw a Y-AE graph showing an economy with an inflationary gap. What would t

Answer 1

To achieve the potential GDP of 3,500, the student must use two methods: direct calculation by inserting the values into the equations and using the multiplier effect calculated from the given MPC. After solving, they can find the necessary change in government spending to reach the potential GDP.

Step-by-step explanation:

The student's question involves determining the necessary change in government spending to achieve a potential GDP of 3,500 in a given economic model. To find the equilibrium level of output for this economy and determine the change in government spending needed, two methods can be applied:

• Direct calculation by plugging potential GDP into the existing equations.
• Using the multiplier effect associated with the marginal propensity to consume (MPC).

To calculate directly, we substitute Y (national income) with 3,500 and T (taxes) with 0.25Y in the aggregate expenditure (AE) equation:
AE = C + I + G + X - M, where C is consumption, I is investment, G is government spending, and X and M are exports and imports respectively.

To use the multiplier method, we calculate the spending multiplier using the formula 1/(1 - MPC), considering the marginal propensity to import and the tax rate.

After solving, you can determine the required change in G to achieve the desired potential GDP, and in doing so, understand the concept of automatic fiscal stabilization and its impact on the economy.