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Chapter 13: Q. 9 (page 297)

Consider the diagram below, in which the current short-run equilibrium is at point $A$ , and answer the questions that follow.
a. What type of gap exists at point $A$ ?
b. If the marginal propensity to save equals $0.02$ , what change in government spending financed by borrowing from the private sector could eliminate the gap identified in part (a)? Explain.

Short Answer

Expert verified

a) The type of gap that is determined from the level is the recessionary gap

b) The needed amount of spending is determined as $ 0.20 trillion

Step by step solution

01

Introduction

The given is the current short-run equilibrium is at point $A

The objective is to determine the type of gap and the change in government spending

02

Explanation (part a)

a)

Since the current equilibrium at $A$ ,

where real GDP is $$ 18$ trillion and potential GDP is $$ 19$ trillion,

This indicates that there is a recessionary void.

03

Explanation (part b)

b)

The $$ 1$ trillion budget deficit must be closed by expanding government spending.

The multiplier is $5$ when the value of MPS is $$ 0.2$ .

As a result, $$ 0.20$ trillion in spending is necessary.

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Most popular questions from this chapter

Assume that MPC = $\frac{4}{5}$ when answering the following questions.

a. If government expenditures rise by \( 1 billion, by how much will the aggregate expenditure curve shift upward?

b. If taxes rise by \) 1 billion, by how much will the aggregate expenditure curve shift downward?

c. If both taxes and government expenditures rise by $ 1 billion, by how much will the aggregate expenditure curve shift? What will happen to the equilibrium level of real GDP?

d. How does your response to the second question in part (c) change if MPC = $\frac{3}{4}$ ? If MPC = $\frac{1}{2}$ ?

Recall that the Keynesian spending multiplier equals 1 /(1-MPC). Suppose that in panel (a) of Figure 13-1, the government determined that the amount by which the AD curve had to be shifted directly rightward from the point E1 was equal to \(1.0 trillion. If the government decided that a \)0.2 trillion increase in real government spending was required to generate this shift, what must be the value of the MPC?

Determine whether each of the following is an example of a situation in which a direct expenditure offset to fiscal policy occurs.

a. In an effort to help rejuvenate the nation's railroad system, a new government agency buys unused track, locomotives, and passenger and freight cars, many of which private companies would otherwise have purchased and put into regular use.

b. The government increases its expenditures without raising taxes. To cover the resulting budget deficit, it borrows more funds from the private sector, thereby pushing up the market interest rate and discouraging private planned investment spending.

c. The government finances the construction of a classical music museum that otherwise would never have received private funding.

1. How does unemployment compensation function as an automatic stabilizer?

The U.S. government is in the midst of spending more than $\(1$ billion on seven buildings containing more than $100, 000$ square feet of space to be used for the study of infectious diseases. Prior to the government's decision to construct these buildings, a few universities had been planning to build essentially the same facilities using privately obtained funds. After construction on the government buildings began, however, the universities dropped their plans. Evaluate whether the government's $\) 1$ billion expenditure is actually likely to push U.S. real GDP above the level it would have reached in the absence of the government's construction spree.

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