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Q.1 - Problems

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Economics Today
Found in: Page 302

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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 17 . 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 $175billion

c. By $175billion

See the step by step solution

Step by Step Solution

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 = $18.55trillion

Real GDP at present = $18.2trillion

Change in real GDPY=18.55-18.2=0.35

MPC = 0.5

Invest multiplier =ΔYΔI

ΔYΔI=11-MPC

role="math" localid="1651983785298" I=350 billion ×0.5=175

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

Step 4: explanation part (c)

We know,

change in real GDP = Y

Tax Multiplier =ΔYΔT

role="math" localid="1651983919228" YT=-MPCMPS

0.35 trillion ΔT=-0.50.5=-1T=175

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

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