Question

1a. The government of Turkey is facing a recession. Presume they plan a tax cut of 40 Billion Euros and spending increase of 20 Billion. The MPC is 0.60. We are curious what the fiscal multiplier will be from the policy. What would be the total increase in GDP based on the fiscal multiplier using the data above?

1b. Using a more realistic multiplier - Let’s add some realism to the exercise and include the effects of taxes and import leakages on the multiplier. Assume, taxes are 0.30 and imports are 0.35. What is the change in GDP when you include these values in your multiplier calculation?

no reference

Answer 1

Solution

1(a)

We know for a closed economy tax multiplier is

TM=MPC/(1-MPC)

here MPC=0.6

So

TM=0.6/(1-0.60)

TM=0.6/0.4

TM=1.5

so

if tax equals to $40 Billion

than increase in GDP = Tax multiplier * decrease in tax

increase in GDP =1.5*40

increase in GDP =$60billion

1(b)

For an open economy

Tax multiplier(TM) = MPC/[1-{MPC(1-MPT)+MPM}]

MPM( marginal propensity to import ) =0.35

MPT(marginal propensity to tax)=0.30

TM=0.60/[1-{0.60(1-030)+0.35}]

TM=0.60/[1-{(0.60*0.70)+0.35}]

TM=0.60/[1-{0.42+0.35}]

TM=0.60/[1-0.77]

TM=0.60/0.23

TM=2.60

So

If Tax decrease by $40 Billion

Than

increase in GDP = Tax multiplier * decrease in tax

increase in GDP =2.6*40

increase in GDP =$104billion