Short Answer

Assume that equilibrium real GDP is $ 18.2 trillion and full-employment equilibrium (F E) is $ 18.55 trillion. The marginal propensity to save is $\frac{1}{7}$ . Answer the questions using the data in the following graph.

a. What is the marginal propensity to consume?
b. By how much must new investment or government spending increase to bring the economy up to full employment?
c. By how much must government cut personal taxes to stimulate the economy to the full employment equilibrium?

a. $0.5$

b. By $$ 175$ billion

c. By $$ 175$ billion

See the step by step solution

Step by Step Solution

TABLE OF CONTENTS :

TABLE OF CONTENTS

Step 1: introduction

Marginal Propensity to consume is the proportion of expansion in utilization because of progress in Income. Marginal Propensity to save is the proportion of expansion in saving because of progress in Income.

Step 2: explanation part (a)

We know,

Marginal Propensity to save = $0.5$

Marginal Propensity of consume + Marginal Propensity of Save = $1$

Hence Marginal Propensity to consume = $1 - 0.5 = 0.5$

Step 3: explanation part (b)

Given,

Real GDP at full employment = $$ 18.55$ trillion

Real GDP at present = $$ 18.2$ trillion

Change in real GDP $∆ Y =$ $18.55 - 18.2 = 0.35$

MPC = $0.5$

$Invest multiplier = \frac{Δ Y}{Δ I}$

$\Rightarrow \frac{Δ Y}{Δ I} = \frac{1}{1 - M P C}$

role="math" localid="1651983785298" $∆ I = 350 billion \times 0.5 = 175$

new investment or government spending increases to $$ 175$ billion bring the economy up to full employment

Step 4: explanation part (c)

We know,

change in real GDP = $∆ Y$

$Tax Multiplier = \frac{Δ Y}{Δ T}$

role="math" localid="1651983919228" $\Rightarrow \frac{∆ Y}{∆ T} = \frac{- M P C}{M P S}$

$\frac{0.35 trillion}{Δ T} = \frac{- 0.5}{0.5} = - 1 \Rightarrow ∆ T = 175$

The government must cut personal taxes by $$ 175$ billion to stimulate the economy to the full employment equilibrium.

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