Question #59905

Suppose that the economy is in recession with a recessionary gap of $1 trillion. The MPC is 0.9 and the tax rate on income is 30%. Answer the following
(a) Compute the value of the multiplier.
(b) Suppose the AS curve is completely flat. What would be the change in G needed to make the gap equal to zero?
(c) Would the change in G you found in b. be enough if the AS curve was positively sloped? Explain using the appropriate graph.

Expert's answer

Recessionary gap of $1 trillion, c = 0.9, t = 0.3.

(a) The value of the multiplier is m = 1/(1 - c*(1 - t)) = 1/(1 - 0.9*(1 - 0.3)) = 1/0.37 = 2.7.

(b) If the AS curve is completely flat, then the change in G needed to make the gap equal to zero is changeY/changeG = m, so:

1/changeG = 2.7, change in G = 1/2.7 = $0.37 trillion.

(c) If the AS curve was positively sloped, then this change may be lower than it is needed.

(a) The value of the multiplier is m = 1/(1 - c*(1 - t)) = 1/(1 - 0.9*(1 - 0.3)) = 1/0.37 = 2.7.

(b) If the AS curve is completely flat, then the change in G needed to make the gap equal to zero is changeY/changeG = m, so:

1/changeG = 2.7, change in G = 1/2.7 = $0.37 trillion.

(c) If the AS curve was positively sloped, then this change may be lower than it is needed.

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