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Chapter 13: Q.18 (page 298)

Recall that the Keynesian spending multiplier equals 1 /(1-MPC). Suppose that in panel (b) of Figure 13-1, the government knows that the MPC is equal to 0.75 and that the amount of the horizontal distance that the AD curve had to be shifted directly leftward from point E1 was equal to $1.0 trillion. What is the reduction in real government spending required to have generated this shift?

Short Answer

Expert verified

The reduction in real government spending required is$0.25trillion

Step by step solution

01

introduction

Spending Multiplier: It is a proportion of the degree to which GDP changes because of an adjustment of arranged venture spending or government spending. Marginal Propensity to Consume alludes to the extent of the absolute expansion in discretionary cash flow that families give to utilization.

02

explanation

We know,

MPC = 0.75

The spending multiplier can be calculated as,

role="math" localid="1651935485004" =11鈭�MPC=11鈭�0.75=4

the decline in government expenditure be鈭�Gand leftward shift on the AD curve be鈭�AD=$1trilion

the decline in government expenditure

role="math" localid="1651935751198" 螖骋=螖础顿spending multiplier=14=0.25

The reduction in real government spending required is$0.25trillion

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Most popular questions from this chapter

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.

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.

Determine whether each of the following is an example of a situation in which there is indirect crowding out resulting from an expansionary fiscal policy action.

a. The government provides a subsidy to help keep an existing firm operating, even though a group of investors otherwise would have provided a cash infusion that would have kept the company in business.

b. The government reduces its taxes without decreasing its expenditures. 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. Government expenditures fund construction of a high-rise office building on a plot of land where a private company otherwise would have constructed an essentially identical building.

A government is currently operating with an annual budget deficit of \(40 billion. The government has determined that every \)10 billion reduction in the amount it borrows each year would reduce the market interest rate by 0.1 percentage point. Furthermore, it has determined that every 0.1-percentage-point change in the market interest rate generates a change in planned investment expenditures in the opposite direction equal to \(5 billion. The marginal propensity to consume is 0.75. Finally, the government knows that to eliminate an inflationary gap and take into account the resulting change in the price level, it must generate a net leftward shift in the aggregate demand curve equal to \)40 billion. Assuming that there are no direct expenditure offsets to fiscal policy, how much should the government increase taxes? (Hint: How much new private investment spending is induced by each $10 billion decrease in government spending? )

Currently, a government's budget is balanced. The marginal propensity to consume is \(0.80. The government has determined that each additional \)10 billion it borrows to finance a budget deficit pushes up the market interest rate by role="math" localid="1651613391961" 0.1 percentage point. It has also determined that every role="math" localid="1651613378175" 0.1-percentage point change in the market interest rate generates a change in planned investment expenditures equal to \(2 billion. Finally, the government knows that to close a recessionary gap and take into account the resulting change in the price level, it must generate a net rightward shift in the aggregate demand curve equal to \)200 billion. Assuming that there are no direct expenditure offsets to fiscal policy, how much should the government increase its expenditures? (Hint: How much private investment spending will each $10 billion increase in government spending crowd out?)
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