Consider a hypothetical closed economy in which the marginal propensity to consume (MPC) is 0.5 and taxes do not vary with income (that is,taxes are fixed rather than variable and the income tax rate t = 0). The following graph shows the aggregate demand curves (AD1 and AD2), theshort-run aggregate supply (AS) curve, and the long-run aggregate supply curve at the potential GDP level. The economy is currently at point A.PRICE LEVEL140Potential GDP136132128124A120116112108400500600AD 2AD₁700800900AS12410001100 1200REAL GDP (Billions of dollars)The economy is currently experiencing a recessionarygap of $billion.To close this gap, one option would be for the government to decreasenot change).government purchases by $billion (assuming net taxes doIf the government kept its purchases constant, it could also close the gap by cutting(Hint: In this case, since taxes do not vary with income, the formula for the multiplier for a change in fixed taxes isnet taxes (taxes minus transfers) by $.)billion.MPC1- MPC

Consider a hypothetical closed economy in which the marginal propensity to consume (MPC) is 0.5 and…

Answered: Consider a hypothetical closed economy…

Survey Of Economics

10th Edition

ISBN:9781337111522

Author:Tucker, Irvin B.

Publisher:Tucker, Irvin B.

Chapter15: Fiscal Policy

Section: Chapter Questions

Problem 6SQ

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Consider a hypothetical closed economy in which the marginal propensity to consume (MPC) is 0.5 and taxes do not vary with income (that is, taxes are fixed rather than variable and the income tax rate t = 0). The following graph shows the aggregate demand curves (AD₁ and AD2), the short-run aggregate supply (AS) curve, and the long-run aggregate supply curve at the potential GDP level. The economy is currently at point A. PRICE LEVEL 140 Potential GDP 136 132 128 124 A 120 116 112 108 400 500 600 AD 1 AD2 AS 124 700 800 900 1000 1100 1200 REAL GDP (Billions of dollars) ? The economy is currently experiencing a recessionary gap of $ billion. To close this gap, one option would be for the government to decrease not change). government purchases by $ billion (assuming net taxes do If the government kept its purchases constant, it could also close the gap by cutting ▼ net taxes (taxes minus transfers) by $ - MPC (Hint: In this case, since taxes do not vary with income, the formula for the…
Consider a hypothetical closed economy in which the marginal propensity to consume (MPC) is 0.5 and taxes do not vary with income (that is, taxes are fixed rather than variable and the income tax rate t = 0). The following graph shows the aggregate demand curves (AD₁ and AD₂), the short-run aggregate supply (AS) curve, and the long-run aggregate supply curve at the potential GDP level. The economy is currently at point A. PRICE LEVEL 140 136 132 128 124 120 116 112 108 100 200 Potential GDP The economy is currently experiencing AD 1 AD2 AS 124 300 400 500 600 REAL GDP (Billions of dollars) 700 800 To close this gap, one option would be for the government to not change). 900 gap of $ billion. government purchases by $ billion (assuming net taxes do If the government kept its purchases constant, it could also close the gap by net taxes (taxes minus transfers) by $ MPC (Hint: In this case, since taxes do not vary with income, the formula for the multiplier for a change in fixed taxes is…
Due to an increase in consumer wealth, there is a $40 billion autonomous increase in consumer spending in the economies of Westlandia and Eastlandia. Assuming that the aggregate price level is constant, the interest rate is fixed in both countries, and there are no taxes and no foreign trade, complete the accompanying tables to show the various rounds of increased spending that will occur in both economies if the marginal propensity to consume is 0.5 in Westlandia and 0.75 in Eastlandia. What do your results indicate about the relationship between the size of the marginal propensity to consume and the multiplier?
Consider two hypothetical economies that are perfectly similar except for their marginal propensity to consume (MPC). Each economy is currently in equilibrium with real income and planned expenditure equal to $100 billion, as given by the black points (plus signs) on the following two graphs. Assume that both economies are closed to trade, and that neither economy has taxes that change with income. The graphs also plot the 45-degree line. The first economy has an MPC equal to 0.5. Therefore, its initial planned expenditure line has a slope of 0.5 and passes through the point (100, 100). The second economy has an MPC equal to 0.75. Therefore, its initial planned expenditure line has a slope of 0.75 and passes through the point (100, 100). Now, suppose there is an increase of $20 billion in planned investment in each economy. In the first economy (with MPC = 0.5), the $20 billion increase in planned investment causes equilibrium income to increase by billion. In the second…
Consider a hypothetical closed economy in which there are no income taxes. If households spend $0.75 of each additional dollar they earn and save the remainder, the expenditure multiplier for this economy is The following graph shows the initial aggregate demand (AD) and short-run aggregate supply (SRAS) curves of this economy. Suppose that the economy is currently in a recession. Business firms are pessimistic about the future and do not respond to a fall in interest rates. In addition, all households are pessimistic about job prospects and desire to consume less and save more at all levels of income. As a result, personal consumption in this economy decreases by $1 billion. The reduction in personal consumption will lead to a decrease in aggregate demand by S Shift either the AD curve or the SRAS curve, or both, to show the new aggregate demand curve after the full impact of the multiplier process of the reduction in personal consumption has taken place. PRICE LEVEL (Billions of…
Consider two closed economies that are identical except for their marginal propensity to consume (MPC). Each economy is currently in equilibrium with real GDP and total expenditure equal to $100 billion, as shown by the black points on the following two graphs. Neither economy has taxes that change with income. The grey lines show the 45-degree line on each graph. The first economy's MPC is 0.5. Therefore, its initial total expenditure line has a slope of 0.5 and passes through the point (100, 100). The second economy's MPC is 0.70. Therefore, its initial total expenditure line has a slope of 0.70 and passes through the point (100, 100). Now, suppose there is an increase of $30 billion in investment in each economy. Place a green line (triangle symbol) on each of the previous graphs to indicate the new total expenditure line for each economy. Then place a black point (plus symbol) on each graph showing the new level of equilibrium output. (Hint: You can see the slope and vertical…
Consider two closed economies that are identical except for their marginal propensity to consume (MPC). Each economy is currently in equilibrium with real GDP and total expenditure equal to $100 billion, as shown by the black points on the following two graphs. Neither economy has taxes that change with income. The grey lines show the 45-degree line on each graph. The first economy's MPC is 0.5. Therefore, its initial total expenditure line has a slope of 0.5 and passes through the point (100, 100). The second economy's MPC is 0.70. Therefore, its initial total expenditure line has a slope of 0.70 and passes through the point (100, 100). Now, suppose there is an increase of $30 billion in investment in each economy. Place a green line (triangle symbol) on each of the previous graphs to indicate the new total expenditure line for each economy. Then place a black point (plus symbol) on each graph showing the new level of equilibrium output.
The following are exogenous (not directly affected by income): G = 9 I = 14 X = M = 0 The consumption function is: C = k + cY, where k = 8, c = 0.6 What is the equilibrium level of GDP? State to ONE decimal place What is the multiplier for this economy? The following are exogenous (not directly affected by income): G = 11 I = 4 X = M = 0 The consumption function is: C = k + cY, where k = 3, c = 0.8 What is the equilibrium level of GDP? What is the multiplier? Same information as in the previous question: The following are exogenous (not directly affected by income): G = 11 I = 4 X = M = 0 The consumption function is: C = k + cY, where k = 3, c = 0.8 Imagine the maximum potential output or real GDP of this economy is 100. Assume that is the same as saying we reach the edge of the PPF at 100. Now assume we want to get that economy from the current level of GDP to its maximum potential of 100. We can do this in two ways - either increase government spending (G) or reduce taxes, (we…
Assume that a hypothetical economy with an MPC of .8 is experiencing severe recession. By how much would government spending have to increase to shift the aggregate demand curve rightward by $25 billion? How large a tax cut would be needed to achieve the same increase in aggregate demand? Why the difference? Determine one possible combination of government spending increases and tax decreases that would accomplish the same goal.
On the following graph, show the effect of the change in investment demand on the AD curve once the multiplier process has run its course. Use the green curve (triangle symbol) to plot the new AD curve at price levels of 40 and 140. Hint: Use the new quantity of investment demanded you found in the Market for Investment and the multiplier to determine the exact change in aggregate demand at both price levels. Assume that this effect is independent of the price level, that is, the AD curve has a parallel shift. An expansionary monetary policy causes the quantity of bank reserves in the economy to ________(INCREASE/DECREASE) , which drives interest rates _______ (UP / DOWN) . As a result, businesses invest______(MORE/LESS) in capital improvements such as new factories and equipment. This leads to ________(AN INCREASE. A DECERASE) in aggregate demand, the extent of which is determined by the simple spending multiplier.
In the following figure, the economy is initially in equilibrium at full-employment at point “e”. Assume that consumption falls by 100 leading to a shift in AD from AD1 to AD2. What is the new short-run macroeconomic equilibrium price and output? How large is the spending multiplier if there were no changes in the aggregate price level? How large is the spending multiplier if the aggregate price level adjusts to the new equilibrium?
In an effort to increase output in the short run due to the poor economy, government officials have decided to cut taxes. They are considering two possible temporary tax cuts of equal size in terms of lost revenue. The first would reduce the taxes on people with incomes above $100,000 per year. The second would cut taxes on people with incomes below $60,000 for one year. Which change would have a greater impact on aggregate spending (i.e shift the aggregate demand curve further to the right)? Why?

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