The government plans to raise state spending by $2bn in the next fiscal year. Economists estimate that consumers will spend, on average, 80 per cent of any increase in income they receive after tax and that the marginal propensity to import is 0.25. The government’s marginal tax rate is 30%. The government argues that this increase in spending will be sufficient to remove a deflationary gap in the economy, estimated as equivalent to a deficiency of aggregate expenditure of $4bn.
a. Calculate the change in national income that can be expected from the $2bn of extra government spending.
b. Comment on the government’s forecast that the $2bn in extra state spending is sufficient to remove the deflationary gap and restore full employment.