Question

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

a. If government expenditures rise by \( 2 billion, by how much will the aggregate expenditure curve shift upward? By how much will equilibrium real GDP per year change?

b. If taxes increase by \) 2 billion, by how much will the aggregate expenditure curve shift downward? By how much will equilibrium real GDP per year change?

Short answer

a. by$\$10$trillion

b. by$\$8$billion

Step-by-step solution

introduction

Tax multiplier addresses sway on Real Output because of progress in the Tax rate.

Government Multiplier addresses change in Real GDP because of progress in Government Expenditure

explanation part (a)

Given,

MPC = $\frac{4}{5}$

Change in government expenditures role="math" localid="1651984325430" $∆G=\$2$billion

we know, $\frac{\Delta Y}{\Delta G}=\frac{1}{1-MPC}$

$\frac{\Delta Y}{2}=\frac{1}{1-0.8}=10$

equilibrium real GDP per year will change by$\$10$trillion

explanation part (b)

Increase in the taxes = $\$2$billion

MPC= $0.8$

now

$\begin{array}{r}\mathrm{MPS}=1-\mathrm{MPC}\\ \mathrm{MPS}=1=0.8\\ \mathrm{MPS}=0.2\end{array}$

Tax multiplier =

$\frac{\mathrm{△}Y}{\mathrm{△}T}=\frac{-MPC}{MPS}$

$\frac{\mathrm{\Delta }Y}{2}=\frac{-0.8}{0.2}=-4$

role="math" localid="1651985298350" $\Rightarrow \mathrm{△}Y=-8$

equilibrium real GDP per year changes by$\$8$billion