Question

# In 1993, Congress failed to pass President Clinton's \$16 billion economic stimulus package intended to create...

In 1993, Congress failed to pass President Clinton's \$16 billion economic stimulus package intended to create jobs. A major criticism was that his new government spending was not matched by tax increases. Assume (for this problem) a similar situation exists now and the U.S. economy is below full employment and Congress had passed a law that requires than an increase in government spending of \$16 billion be matched or balanced by an equal increase in taxes. The MPC = 0.75 and aggregate demand must be increased by \$20 billion to reach full employment. Will the economy reach full employment if Congress increases spending by \$16 billion and increases taxes by the same amount? Show or describe why or why not for full credit.

Due to increase in government spending of \$16 Billion,

Increase in AD = 16*(1/(1-MPC) = 16*(1/(1-.75))

Increase in AD = \$64 Billion

==

Due to decrease in tax of \$16 Billion,

Decrease in AD = 16*(MPC/(1-MPC) = 16*(.75/(1-.75))

Decrease in AD = \$48 Billion

So,

net increase in AD = 64 - 48

net increase in AD = 16 Billion

Since the gap is of \$20 Billion, but plan of spending and tax increase, only increases AD by \$16 Billion, then economy will not be able to achieve full employment level with this plan.

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