Question

In 2009, the US Federal government cut taxes by approximately $300 billion, increased government spending by approximately $300 billion, and increased transfer payments by approximately $200 billion. Answer the following questions assuming that the marginal propensity to consume was 0.75.

A. What was the maximum change in GDP from the government spending?

Answer 1

The maximum change in GDP from government spending can be calculated using the multiplier effect. The multiplier effect refers to the idea that an initial increase in spending can have a larger impact on the economy. In this case, assuming a marginal propensity to consume of 0.75, the maximum change in GDP from government spending would be $1200 billion.

Step-by-step explanation:

To calculate the maximum change in GDP from government spending, we need to use the multiplier effect. The multiplier effect refers to the idea that an initial increase in spending can have a larger impact on the economy.

In this case, the government increased spending by approximately $300 billion. The multiplier effect can be calculated by using the formula: multiplier = 1 / (1 - marginal propensity to consume).

Given that the marginal propensity to consume is 0.75, the multiplier would be 1 / (1 - 0.75) = 4. Using this multiplier, we can calculate the maximum change in GDP from government spending as follows:

1. Calculate the change in government spending: $300 billion
2. Multiply the change in government spending by the multiplier: $300 billion * 4 = $1200 billion

Therefore, the maximum change in GDP from government spending would be $1200 billion.