Question

# I. Completely answer the following problems:  uses the correct equations to explain the exercises, please 1. The...

I. Completely answer the following problems:  uses the correct equations to explain the exercises, please

1. The economy is in equilibrium of full employment at \$ 825 billion. However, aggregate demand increases causing GDP to be at the level of \$ 1,225 trillion. Note that the economy registers a PMC = 0.60.

+a. What type of fiscal policy will have to be implemented (restrictive fiscal policy or expansive fiscal policy)?

+b. If applying a fiscal policy using only government spending (G), by how much would government spending have to increase or decrease to return to full employment GDP.

+c. To apply a fiscal policy exclusively using the tax tool (T), by how much would you have to increase or decrease taxes to return to full employment GDP.

+d. If a dual fiscal policy is applied, that is, using taxes (T) and government expenses (G), by how much would T and G have to increase or decrease to return to the GDP of full employment

(a)

Since actual GDP is higher than full employment GDP, economy is experiencing an inflationary gap, which requires use of restrictive fiscal policy (decreasing government spending or increasing taxes).

(b)

Inflationary gap = 1,225 - 825 = 400 trillion

Spending multiplier = 1 / (1 - MPC) = 1 / (1 - 0.6) = 1/0.4 = 2.5

Decrease in G = Inflationary gap / Spending multiplier = 400 trillion / 2.5 = \$160 trillion

(c)

Tax multiplier = - MPC / (1 - MPC) = - 0.6 / (1 - 0.6) = - 0.6/0.4 = - 1.5

Increase in T = Inflationary gap / Tax multiplier = 400 trillion / 1.5 = \$266.67 trillion

(d)

With restrictive fiscal policy and balanced budget multiplier being equal to 1,

Required decrease in G = Simultaneous increase in T = Inflationary gap = \$400 trillion