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ANALYZE THE ISSUE Assume $100 billion is spent on infrastructure this year, and this spending is entirely funded by raising taxes (which might include gas taxes, collecting tolls, imposing user fees, or other forms of taxation) of $ 100 billion. Use the Keynesian aggregate expenditures model to explain the impact on real GDP. Assume the MPC = 0.90, the economy is initially in equilibrium at $18 trillion, and there is a recessionary gap equal to $100 billion. What will the new equilibrium level of real GDP be equal to? Will this infra-structure spending, financed by raising taxes of an equal amount, be sufficient to close the recessionary gap?
Economics For Today
Solutions
Economics For Today
ANALYZE THE ISSUE Assume $100 billion is spent on infrastructure this year, and this spending is entirely funded by raising taxes (which might include gas taxes, collecting tolls, imposing user fees, or other forms of taxation) of $ 100 billion. Use the Keynesian aggregate expenditures model to explain the impact on real GDP. Assume the MPC = 0.90, the economy is initially in equilibrium at $18 trillion, and there is a recessionary gap equal to $100 billion. What will the new equilibrium level of real GDP be equal to? Will this infra-structure spending, financed by raising taxes of an equal amount, be sufficient to close the recessionary gap?
The new equilibrium level of GDP in the economy.
Explanation of Solution
It is given that the increase in the infrastructure is by $100 billion and it is also said that the increased spending is completely funded with the increased tax revenue in the economy. The marginal propensity to consume is 0.90 and the initial equilibrium in the economy is at $18 trillion. The economy experiences a recessionary gap of $100 billion. When the economy faces the infrastructural investment, it would lead to the spending multiplier times increase in the GDP of the economy.
The spending multiplier can be calculated as follows;
Thus, when the economy faces an increased infrastructural investment of $100 billion, the total GDP of the economy would increase by $1 trillion
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