Assume that the equilibrium real
The change to eliminate the recessionary gap when government spending and taxes both change by the same amount.
Explanation of Solution
To calculate recessionary gap when government spending and taxes both change by the same amount follow the steps
Step-1
Calculate the gross domestic product gap
Given Information:-
Real Gross Domestic Product
Potential Gross Domestic Product
Substitute the value in the mentioned formula:-
Step-2
Calculate the tax multiplier for the given data
Where MPS is marginal propensity to save that means the amount the consumers save from their income rather spending on goods and services.
MPI stands for marginal prosperity to invest.
MPC stands for marginal propensity to consume.
Here, given information:-
MPC is
MPS can be calculated as
Now substitute the value in the given formula in tax multiplier formula
The value of tax multiplier is
Step 3
Calculate the government spending multiplier
Now, formula for calculating multiplier is:-
Where MPS is marginal propensity to save that means the amount the consumers save from their income rather spending on goods and services.
MPI is stands for marginal propensity to invest.
Here, MPI is
MPS can be calculated as
Now substitute the value in the formula:-
The value of multiplier is
Step 4
Now to close the gap the combined effect of both government spending and tax cut will be
According to the question increase in government spending is of same amount as of Tax cut
Let's consider government spending as x, therefore tax cut will also be x
Substitute the value in the above equation:-
Calculate for x
Now to calculate the recessionary gap, add both the values of government spending and tax cut
Therefore,
Concept Introduction:
Gross Domestic Product is the total amount of finished products and services produced with in the country. It majorly calculates the economic growth of a country. The dissimilarity between potential Gross Domestic Product and real Gross Domestic Product is known as Gross Domestic Product gap.
When real GDP is lower than the potential GDP, there occurs a recessionary gap. When an economy is forthcoming recession, recessionary gap occurs.
Want to see more full solutions like this?
- What are characteristics of an economy that helps itself correct from a recessionary gap.arrow_forwardWhat is the multiplier effect during a recession and full employment?arrow_forwardConsider an economy that is operating below the full-employment level of real GDP. What would be the effect of an increase in government spending on aggregate demand and real GDP?arrow_forward
- Suppose that consumption is 70 million and disposable income is 350 and that the economy is experiencing a recessionary gap of 66 million. If the government spent 2 million and taxes were cut by 5 million, what happens to the GDP gap?arrow_forwardWhat is the difference between an expansionary(inflationary gap) gap and contractionary(recessionary) gap?arrow_forwardQuestion 4Assume that the economy has a recessionary gap. Explain how the economy will remove this gap without government intervention. Use graphs to illustrate your answer. Assume that the economy has an inflationary gap. Explain how the economy will remove this gap without government intervention. Use graphs to illustrate your answer.arrow_forward
- Economics (MindTap Course List)EconomicsISBN:9781337617383Author:Roger A. ArnoldPublisher:Cengage Learning