Final answer:
A tax cut of $200 billion is needed to increase total spending by $1 Trillion and return the economy to full employment, given a marginal propensity to consume of 0.8.
Step-by-step explanation:
To determine the tax cut needed to increase total spending by $1 Trillion and achieve full employment output given a marginal propensity to consume (MPC) of 0.8, we utilize the concept of the multiplier effect. To bring the economy back to full employment, we need to increase total spending by $1 trillion. The marginal propensity to consume (MPC) is 0.8, which means that 80% of any increase in income will be spent.
The multiplier (k) is calculated as 1/(1 - MPC), which in this case is 1/(1 - 0.8) = 5. To achieve a $1 Trillion increase in total spending, we divide the increase needed by the multiplier: $1 Trillion / 5 = $200 billion. Thus, a $200 billion tax cut is required to raise spending by $1 Trillion and bring the economy back to full employment.
It's important to note that this is a simplified approach that assumes all other economic factors remain constant and disregards possible changes in consumer behavior, potential price level changes, or policy lags.