# 1. President Nellie L. Inzer is faced with a severe recession where real aggregate output is \$15 trillion.Unemployment rates hover at 10%, and at full employment the CBO estimates that the national income shouldbe \$18 trillion; in addition, your statisticians have calculated that your citizens consume an additional 80 dollars100 dollars they receive in additional disposable income. Having taken her dad's Honors Economicsforeveryclass, President Nellie ponders an economic solution--she's halted all international trade and has fixed interestrates.She is faced with three possible decisions from her Council of Economic Advisors to fight this major recessionI. Lower taxes for her citizens by \$500 billion.II. Buy \$500 billion in "green" technologies (goods and services) aimed at making the Americangovernment more eco-friendly.III. Reduce government expenditures on goods and services by \$700 billion while simultaneouslyincreasing Transfer payments to citizens by \$900 billion. Assume that these measures may not affect eachother and that the net effects can be calculated simply without regard to the multitude of variables onemight think occurs. Ignore reality a bit.

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Question: Since you took Mr. Inzer’s Honors Economics course, you question your Economic advisors.  Based on what you know about economics, what policy should Nellie Bellie enact to close the output gap?  Explain, using an actual example and precise numbers; show your calculations.

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Step 1

Given:

Real output = \$15 trillion

Unemployment rate = 10%

If there is full employment, National income will be = \$18 trillion

Consumption is \$80 for every additional \$100 that is change in consumption is \$80 when income changes by \$100.

So, MPC = Change in consumption/Change in income = 80/100 = 0.8

Also, we know that there will be a multiplier effect when there is an increase in final income due to new injections of spending in the economy.

Multiplier effect can be calculated by the formula (for government expenditure):  1/ (1-MPC) = 1/ (1-0.8) = 5 times

Tax multiplier = -MPC/ 1-MPC = -0.8 / 0.2 = -4 times

Transfer payment multiplier = MPC / 1-MPC = 0.8 / 0.2  = 4 times

Step 2

Analysing all the 3 cases:

1)Reducing taxes by \$500 billion, will lead to an increase in the disposable income of the citizens, allowing them to this extra income and thus increasing the aggregate demand.

Taxes reduced = -\$500 billion. We know, tax multiplier = -4

Therefore, total increase in income = 4 * 500 billion = \$2000 billion = \$2 trillion

Thus, the national income will be = 15 trillion + 2 trillion = \$17 trillion

Still there is a gap of 1 trillion after the reduction of taxes by \$500 billion.

Step 3

2) Buying \$500 billion of green technologies will just increase the national income by \$500 billion as it is directly bought and there is no increase in disposable income as the goods are bought and in...

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