Suppose a closed economy with no government spending which in equilibrium is producing an output and income of 2250. Suppose also that the marginal propensity to consume is 0.80, and that, if at full employment, the economy would produce an output and income of 3850 By how much would the government need to cut taxes (T) to bring the economy to full employment?

Suppose a closed economy with no government spending which in equilibrium is producing an output and income of 2250. Suppose also that the marginal propensity to consume is 0.80, and that, if at full employment, the economy would produce an output and income of 3850 By how much would the government need to cut taxes (T) to bring the economy to full employment?

ECON MACRO

5th Edition

ISBN:9781337000529

Author:William A. McEachern

Publisher:William A. McEachern

Chapter9: Aggregate Demand

Section: Chapter Questions

Problem 5.11P

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Suppose a closed economy with no government spending which in equilibrium is producing an output and income of 2500. Suppose also that the marginal propensity to consume is 0.80, and that, if at full employment, the economy would produce an output and income of 3900 By how much would the government need to cut taxes (T) to bring the economy to full employment?
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Consider the following model i) C = 1500 + mpc (Y – tY)ii) I = 800iii) G = 500iv) X – M = 500 – mpi (Y)where:t = the (flat) tax ratempc = the marginal propensity toconsumempi = the marginal propensity toimportsuppose mpc = .80, t = .25, mpi =.2 a. solve for the equilibrium outputb. Solve for the (government) spending multiplier.c When we discussed the multiplier we discussed the impact effect. For example, suppose that G increases by 100 to 600 and we assume, as we often do, that firms match the increase in demand by increasing Y by 100. In round two, this is an increase in income of 100 to consumers. Trace out exactly where this 100 increase in income goes in the second round and compare to our simpler treatment with a closed economy and lump sum taxes. Hint, there are three leakages to address(again, please be very specific as to where the 100 increase income ‘goes’ in this second round).d. What would happen to the multiplier if the mpi rises to .25. Please explain the intuition.