Question

Fast forward 50 years and Melvis Pink today boasts of a modern and expanding economy dependent on its exports of crude and natural gas. Its national income in 2013 was driven by the following indicators (all information is expressed in billions of dollars): Autonomous consumption $50, investment $40, government expenditure $50, autonomous taxes $10, exports $60, imports $40. A welfare state, the federal government handed out $20 billion in transfer payments in 2018. The marginal propensity to consume is 0.6. The income tax rate is 0.30.

e) The autonomous expenditure multiplie

f) The federal budget deficit/surplus

g) Suppose the economy’s potential real GDP is $300. Given the actual level of real GDP calculated in (c), what is the size of the economy’s output gap? Indicate whether it is a recessionary gap or inflationary gap?

h) Given the size of the output gap calculated in (g), recommend the amount of government expenditure that the government must spend in order to bring the economy back to fullemployment?

Answer 1

(e)

Autonomous Expenditure Multiplier = 1 / [1 - MPC(1 - tax rate)]

= 1 / [1 - 0.6(1 - 0.3)]

= 1 / [1 - (0.6 x 0.7)]

= 1 / (1 - 0.42)

= 1 / 0.58

= 1.72

(f)

From initial parts, Equilibrium Y = 286.21

Tax = 0.3Y = 0.3 x 286.21 = 85.86

Since Tax > (Transfer payment + Government expenditure), there is a Budget surplus.

Budget surplus = T - (TR + G) = 85.86 - (50 + 20) = 15.86

(g)

As Potential GDP is higher than Equilibrium GDP, there is a recessionary gap.

Recessionary gap = Potential GDP - Equilibrium GDP = 300 - 286.21 = 13.79

(h)

Required increase in government spending = Recessionary gap / Autnomous Expenditure multiplier

= 13.79 / 1.72 = 8.02