Chapter 4R, Problem 2FRQ

a.

To determine

Spending multiplier is MPS of economy is 0.1.

Explanation of Solution

Spending multiplier can be calculated by using following formula:

  $\begin{array}{c}\text{Spending multiplier}=\frac{\text{1}}{\left(\text{MPS}\right)}\\ =\frac{1}{0.1}\\ =10\end{array}$

Economics Concept Introduction

Multiplier: Spending multiplier can be referred as the ratio indicating the increase in real GDP due to the initial increase of each $1 in spending.

b.

To determine

The value of tax multiplier.

Explanation of Solution

Tax multiplier can be determined as follows:

  $\begin{array}{c}\text{Tax multiplier}=\frac{\text{1}-\text{MPS}}{\left(\text{MPS}\right)}\\ =\frac{1-0.1}{0.1}\\ =9\end{array}$

Economics Concept Introduction

Multiplier: Spending multiplier can be referred as the ratio indicating the increase in real GDP due to the initial increase of each $1 in spending.

c.

To determine

The increase in real GDP due to the increase in government spending by $200 million.

Explanation of Solution

Increase in real GDP will be as follows:

  $\begin{array}{c}\text{Increase in real GDP}=\frac{\text{1}}{\left(\text{MPS}\right)}\times \text{Government spending}\\ =10\times \$200\text{million}\\ \text{=\$2000 million}\end{array}$

Economics Concept Introduction

Real GDP: Real Gross Domestic Products refers to the measure that determines the value of goods and services which are produced in the country within specific time frame after adjusting with inflation.

d.

To determine

The net effect in real GDP if taxes and government spending both are increased by $200 million.

Explanation of Solution

Increase in real GDP will be reduced if taxes and government spending is increased by 200 which is as follows:

  $\begin{array}{c}\text{Increase in real GDP}=\text{Tax multiplier}\times \text{Government spending}\\ =9\times \$200\text{million}\\ \text{=\$1800 million}\end{array}$

Economics Concept Introduction

Real GDP: Real Gross Domestic Products refers to the measure that determines the value of goods and services which are produced in the country within specific time frame after adjusting with inflation.