Question

If the MPC is 0.80 and the government increases spending on cancer research by $15 billion....

If the MPC is 0.80 and the government increases spending on cancer research by $15 billion.
(a) What is the value of the initial impact on real GDP? What is the value of the total impact on real GDP? What effect do you think a $50 billion increase in government spending will have on the economy?
(b) Assume the MPC is 0.80 and policy makers have targeted real GDP to increase by $200 billion. By how much must taxes be reduced to achieve this goal?

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Answer #1

Answer
(a) What is the value of the initial impact on real GDP?

RGDP=C+I+G+NX
increase in spending(G) increases GDP by the same amount initially
so the initial increase is $15 billion

What is the value of the total impact on real GDP?
Sepnding multiplier=1/(1-MPC)
=1/(1-0.8)
=5
total impact=spending multiplier *intial impact
=5*15
=$75 billion


What effect do you think a $50 billion increase in government spending will have on the economy?

it will increase real GDP by =increase in G* multiplier
=50*5
=$250 billion

(b) Assume the MPC is 0.80 and policymakers have targeted real GDP to increase by $200 billion. By how much must taxes be reduced to achieve this goal?
tax multiplier=-MPC/(1-MPC)
=-0.8/(1-0.8)
=-4
the required increase in GDP=tax multiplier*tax change
200=(-4)*tax change
tax change=-50 billion
the taxes should be reduced by $50 billion (the negative sign show reduction.)

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