Question

Assume MPC =0.85. If an initial fiscal restraint of $100 billion is desired, by how much must Instructions: In part a, enter your response as a whole number. In part b, round your response to two decimal places.

a. government spending be reduced? $___
b. taxes be raised? ___billion

Answer 1

To achieve an initial fiscal restraint of $100 billion and assuming the MPC is 0.85, the government spending must be reduced by approximately $666.67 billion and taxes must be raised by approximately $783.67 billion.

Step-by-step explanation:

To calculate the reduction in government spending, we can use the formula:

Multiplier = 1 / (1 - MPC)

By rearranging the equation, we can solve for the reduction in government spending:

Reduction in Government Spending = Initial fiscal restraint / Multiplier

Given that the MPC is 0.85 and the initial fiscal restraint is $100 billion, we can substitute these values into the equation:

Reduction in Government Spending = 100 / (1 - 0.85) = 100 / 0.15 = 666.67 billion dollars.

To calculate the increase in taxes, we can use the formula:

Increase in Taxes = Reduction in Government Spending / MPC

Substituting the values from the previous calculation:

Increase in Taxes = 666.67 / 0.85 = 783.67 billion dollars.