Question

Suppose the economy is operating at its full-employment-noninflationary GDP and the MPC is 0.75. The Federal government now finds that it must increase spending on military goods by $21 billion in response to a deterioration in the international political situation. To sustain full-employment-noninflationary GDP government must:

A)reduce taxes by $28 billion.
B)reduce transfer payments by $21 billion.
C)increase taxes by $21 billion.
D)increase taxes by $28 billion.

Answer 1

To sustain full-employment-noninflationary GDP after a $21 billion increase in government spending, the government should increase taxes by $21 billion to counteract the multiplier effect.

Step-by-step explanation:

If the economy is operating at its full-employment-noninflationary GDP and the marginal propensity to consume (MPC) is 0.75, an increase in government spending will have a multiplied effect on the economy due to the multiplier effect. When the government increases spending by $21 billion, this initial increase circulates through the economy, resulting in a larger impact on the equilibrium level of real GDP. To counteract this effect and avoid inflationary pressure, while sustaining full-employment-noninflationary GDP, the government must increase taxes by the same amount as the spending increase. So, the correct answer is C) increase taxes by $21 billion.

Answer 2

D)increase taxes by $28 billion.

Step-by-step explanation:

Suppose the economy is operating at its full-employment-noninflationary GDP and the MPC is 0.75. The Federal government now finds that it must increase spending on military goods by $21 billion in response to a deterioration in the international political situation. To sustain full-employment-noninflationary GDP government must: