Ab 27 Economics 1. The multiplier effectConsider a hypothetical economy where there are no taxes and no international trade. Households spend $0.90 of each additional dollar they earn andsave the remaining $0.10. If there are no taxes and no international trade, the oversimplified multiplier for this economy is 10.Suppose investment spending in this economy decreases by $200 billion. The decrease in investment will lead to a decrease in income, generating adecrease in consumption that decreases income yet again, and so on.Fill in the following table to show the impact of the change in investment spending on the first two rounds of consumption spending and, eventually,on total output and income.Change in Investment SpendingFirst Change in ConsumptionSecond Change in ConsumptionTotal Change in Output=-$200 billion-$180 billion-$162 billion-$2,000 billionNow consider a more realistic case. Specifically, assume that the government in our hypothetical economy collects income taxes. In this case, themultiplier will be smaller than the oversimplified multiplier you found earlier.Suppose that the price level in our economy remains the same and that there is still no international trade. Now, however, the government decides toimplement an income tax of 5% on each dollar of income. The MPC and MPS, however, remain the same as before. In this case, after accounting forthe impact of taxes, the multiplier in this economy is 10 , and a $200 billion decrease in investment spending will lead to abillionin output.

Oversimplified multiplier= 1/(1-MPC) MPC= 0.9 Oversimplified multiplier= 1/(1-0.9)= 1/0. 1…

onomy where there are no taxes and no international trade. Households spend $0.90 of each additio If there are no taxes and no international trade, the oversimplified multiplier for this economy is ing in this economy decreases by $200 billion. The decrease in investment will lead to a decrease in hat decreases income yet again, and so on. show the impact of the change in investment spending on the first two rounds of consumption sper ending -$200 billion mption mption Output -$180 billion -$162 billion -$2,000 billion tic case. Specifically, assume that the government in our hypothetical economy collects income taxe than the oversimplified multiplier you found earlier. el in our economy remains the same and that there is still no international trade. Now, however, the of 5% on each dollar of income. The MPC and MPS, however, remain the same as before. In this cas ultiplier in this economy is 10 and a $200 billion decrease in investment spending will le in output.

onomy where there are no taxes and no international trade. Households spend $0.90 of each additio If there are no taxes and no international trade, the oversimplified multiplier for this economy is ing in this economy decreases by $200 billion. The decrease in investment will lead to a decrease in hat decreases income yet again, and so on. show the impact of the change in investment spending on the first two rounds of consumption sper ending -$200 billion mption mption Output -$180 billion -$162 billion -$2,000 billion tic case. Specifically, assume that the government in our hypothetical economy collects income taxe than the oversimplified multiplier you found earlier. el in our economy remains the same and that there is still no international trade. Now, however, the of 5% on each dollar of income. The MPC and MPS, however, remain the same as before. In this cas ultiplier in this economy is 10 and a $200 billion decrease in investment spending will le in output.

ECON MACRO

5th Edition

ISBN:9781337000529

Author:William A. McEachern

Publisher:William A. McEachern

Chapter11: Fiscal Policy

Section: Chapter Questions

Problem 1.4P

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5. The multiplier effect of a change in government purchases
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