Question

Using your knowledge of the IS curve and the balanced budget multiplier, answer the questions below.

Assume the following:

MPC is 0.75

Let government spending increase $500 million.

Let net taxes increase $500 million.

Using the IS/LM framework, illustrate the IS shift caused by the increase in government spending. Measured in dollars (GDP) on the horizontal axis, how much did IS shift (what is the magnitude of the horizontal shift)?

Now, on the same chart, illustrate the effect of the tax increase with a third IS curve, showing the change fromthe 2nd IS curve.....in other words, assume government spending increases first, then taxes are increased. By how much does the IS curve shift as a result of the tax increase?

At a fixed (given) interest rate, what is the overall dollar change in GDP resulting from the combined increase of government spending and taxes? Explain and show relevant computations.

Answer #1

With the value of MPC being 0.75 spending multiplier = 1/1-MPC = 1/1-0.75 = 4 and tax multiplier = -MPC/1-MPC = -0.75/0.25 = -3

When G rises by 500, Income is increased by 500*4 = 2000. This shifts the IS to the right by 2000. Next when tax is increased by 500, income is reduced by 500*-3 = -1500 so IS shifts left by 1500. This implies that the net increase in GDP is 500 which is the result we get from a balanced budget multiplier that is equal to 1 for an equal increase in G and T.

The overall dollar change in GDP resulting from the combined increase of government spending and taxes is only 500.

According to the balanced budget multiplier, an increase in
government spending of $10,000 that is financed by an increase of
$10,000 in taxes will have what effect on the economy when MPC is
0.80?
a)
Income will not change.
b)
Income will increase by $8,000.
c)
Income will increase by $50,000.
d)
Income will increase by $10,000.

Question 3 (1 point)
[Question 3 Unsaved]
If the spending multiplier is 8, the tax multiplier is
Question 3 options:
A) 0.
B) -1.
C) -7.
D) -8.
Question 4 (1 point)
[Question 4 Unsaved]
Suppose the marginal propensity to consume (MPC) is 0.90. If the
government increases both its spending and taxes by $50 million,
then aggregate demand will
Question 4 options:
A) increase by $50 million.
B) increase by $45 million.
C) remain unchanged.
D) increase by $4.5...

4. The balanced budget multiplier For both political and
macroeconomic reasons, governments are often reluctant to run
budget deficits. Here, we examine whether policy changes in G and T
that maintain a balanced budget are macroeconomically neutral. Put
another way, we examine whether it is possible to affect output
through changes in G and T so that the government budget remains
balanced.
a. By how much does Y increase when G increases by one
unit?
b. By how much does...

A. Given the values below, is the
value of the spending (Keynesian) multiplier?
What is the value of the tax multiplier?
What is the value of the 'balanced budget multiplier'?
Solve for Y*.
a = 300
MPC = .6
I = 350
G = 400
T = 0
B. Given the values below, solve for
Y* (equilibrium output).
a = 300
MPC = .6
I = 350
G = 400
T = 250
C. Given the values below, solve for...

3 Derive IS curve and LM curve mathmatically:
(1) Consider in a country A money supply M=4000, price level
P=3, inflation expectation and liquidity preference is assumed to
be zero to make the calculation simple. The money demand function
L(i, Y ) = Y ? 200 ? (r + ? ^e ). Use the above information to
derive the LM curve mathmatically and then plot it when real
interest rate is between 0 and 8.
(2) Consider in a country...

3) Which of the
following occurs as the economy moves leftward along a given IS
curve?
A) An increase in the
interest rate causes investment spending to decrease.
B) An increase in the
interest rate causes money demand to increase.
C) An increase in the
interest rate causes a reduction in the money supply.
D) A reduction in
government spending causes a reduction in demand for goods.
E) An increase in taxes
causes a reduction in demand for goods.
5)...

Calculations:
If there a $2billion increase in government spending, other
things being equal, what would be the resulting change in aggregate
demand, and how much of the change would a change in consumption,
if the MPC were the following:
1/3?
1/2?
2/3?
3/4?
4/5?
The economy is experiencing a $225 million inflationary gap. If
the government decided to solve this macroeconomic disequilibrium
using a change in taxes, would you recommend an increase or
decrease in taxes? If the MPC =0.9,...

(1)
If the spending
multiplier equals 10 and the actual equilibrium real GDP is $4
billion below potential real GDP, then other things being equal,
_____ to reach the potential real GDP level.
Group of answer choices
autonomous spending
needs to increase by $40 billion
real GDP needs to
increase by $40 billion
autonomous spending
needs to increase by $4 billion
real GDP needs to
increase by $0.4 billion
autonomous spending
needs to increase by $0.4 billion
(2)
Other things...

Assume that a hypothetical economy with an MPC of 0.75 is
experiencing a severe recession.
a. By how much would government spending have to
rise to shift the aggregate demand curve rightward by $25
billion?
Instructions: Round your answer to two decimal
places.
$ billion
b. How large a tax cut would be needed to achieve
the same increase in aggregate demand?
Instructions: Round your answer to two decimal places.
Enter a positive value.
$ billion
c. Determine one possible combination of...

22.
The crowding out effect is zero if
A)
the LM-curve is horizontal
B)
the LM-curve is vertical
C)
the Fed conducts open market sales following fiscal
expansion
D)
income is stimulated via a tax cut rather than an increase in
government spending
E)
none of the above
23.
Crowding out occurs when
A)
an increase in defense spending causes a decrease in
consumption
B)
expansionary monetary policy fails to stimulate economic
growth
C)
expansionary fiscal policy causes interest rates...

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