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.

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Answer #1

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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