Assuming that the MPC =.75 and that prices are constant, which of the following fiscal policies would eliminate a recessionary gap of $60 billion while maintaining a balanced budget?

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Social Studies

19 October, 10:34

Assuming that the MPC =.75 and that prices are constant, which of the following fiscal policies would eliminate a recessionary gap of $60 billion while maintaining a balanced budget?

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Summer James · Answer 1

Increasing government spending by $60 billion while raising taxes $60 billion

Explanation:

If we do the multiplicator of Government spending which is equal to = 1/MPS

And MPS (marginal propensity to save) = 1 - MPC (marginal propensity to consume)

But MPC = 0.75

Hence multiplicator of Government spending = 1 / (1-0.75) = 4

If we look for the multiplicator of taxes = - MPC/MPS

But MPS = 1 - MPC

= - MPC / (1-MPC)

= - 0.75/0.25 = - 3

Hence if government spending is increased by $60 billion, GDP will be increased by 60 x 4 = $240 billion

Also if taxes are increased by the same amount, GDP will decrease by 60x3 = $180 billion

Hence this means that GDP will increase by 60 billion dollars, as the difference between the both is 240 - 180 = 60 billion dollars