Assume that a hypothetical economy with an MPC of 0.8 is experiencing severe recession.

Instructions: In part a, round your answers to 2 decimal places. Enter your answers as positive numbers. In part b, enter your answers as whole numbers.

a. By how much would government spending have to rise to shift the aggregate demand curve rightward by $30 billion?

How large a tax cut would be needed to achieve the same increase in aggregate demand?

b. Determine one possible combination of government spending increases and tax increases that would accomplish the same goal without changing the amount of outstanding debt.

Increase spending

Increase taxes by

a. i $6B

ii. The government should decrease taxes by $7.5B to achieve $30B increase in the level of output.

b. Possible combination:

Increase government spending by $30B.

Decrease taxes by $30B.

Explanation:

Fiscal policy is a way by which a government adjusts its spending levels and tax rates to predict and influence a nation's economy. It is synonymous to monetary policy through which a central bank influences a nation's money supply into the economy. Fiscal policy is divided into two types namely:expansionary or contractionary fiscal policies.

a)

. Government spending multiplier is a direct increase in the level of output (GDP) as a result of one dollar change in government spending.

By how much would government spending have to rise to shift the aggregate demand curve rightward by $30 billion?

Government spending multiplier:

To calculate government spending multiplier (Kg) using MPC:

(1-0.8) * 30B

=$6B

The government should increase its spending by $6B in order to archives $30B increase in the level of output.

Tax Multiplier:

Calculate tax multiplier (Kt) by using MPC:

The government should decrease taxes by $7.5B to achieve $30B increase in the level of output.

b) Possible combination:

Increase government spending by $30B.

Decrease taxes by $30B.