Suppose the full employment output level in this economy is $300 billion. In order to move the economy to full-employment output at the lowest possible price level, the aggregate demand curve must shift to the right by $80 billion at each price level.
right/left 20/40/60/80 billion
[Us Use the green line (triangle symbols) to show the shift in aggregate demand necessary to return the economy to full employment. Then use the purple drop lines (diamond symbol) to show the macroeconomic equilibrium at full-employment output. Be sure the new aggregate demand curve (AD) is parallel to AD. You can click on AD, to see its slope
Suppose the government in this economy wants to enact fiscal policies that will shift the aggregate demand curve in the direction and magnitude you indicated. The marginal propensity to consume (MPC) in this economy is 0.8. This implies a spending multiplier of and a tax multiplier of 0/13/5/7
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-9/-4/-2/-03
Consider each fiscal policy listed here. Which policies would shift the aggregate demand curve in a way that restores full-employment output at the lowest possible price level? Check all that apply.
Decrease taxes by $25 billion and decrease government expenditures by $8 billion
Increase government expenditures by $80 billion and raise taxes by $80 bilion
Increase taxes by $20 billion
Increase government expenditures by $24 billion and raise taxes by $10 billion
Increase government expenditures by $16 billion
The Correct Answer and Explanation is :
Step-by-Step Explanation:
To understand the given scenario, we first need to break down the problem and consider the important factors:
- Full Employment Output Level: The full employment output level in the economy is $300 billion. The aggregate demand curve needs to shift to the right by $80 billion at each price level to restore full employment. This shift aims to bring the economy back to its full-employment level of output, ensuring the optimal price level.
- Marginal Propensity to Consume (MPC): The MPC is 0.8, which means that for every additional dollar of income, consumers spend 80% and save the remaining 20%. The spending multiplier (k) is calculated using the formula: [
k = \frac{1}{1 – \text{MPC}} = \frac{1}{1 – 0.8} = \frac{1}{0.2} = 5
] This implies that every dollar of government spending will have a five-fold impact on the economy in terms of shifting the aggregate demand. - Fiscal Policy Implications:
- Spending Multiplier: A change in government spending will shift the aggregate demand by five times the actual amount spent. So, a $1 billion increase in government spending will shift the aggregate demand by $5 billion.
- Tax Multiplier: The tax multiplier is the effect of a change in taxes on aggregate demand. It is calculated as the negative of the tax multiplier formula: [
\text{Tax Multiplier} = – \frac{\text{MPC}}{1 – \text{MPC}} = – \frac{0.8}{0.2} = -4
] This means that for every $1 billion increase in taxes, aggregate demand will decrease by $4 billion.
- Required Policy Actions: The aggregate demand must shift by $80 billion to restore the economy to full employment. Now, let’s examine each policy scenario:
1. Decrease taxes by $25 billion and decrease government expenditures by $8 billion:
- Decrease taxes by $25 billion: The tax multiplier is -4, so this would reduce aggregate demand by $100 billion (25 * -4 = -100).
- Decrease government expenditures by $8 billion: This would reduce aggregate demand by $40 billion (8 * -5 = -40).
- Net effect: The total change is a reduction in aggregate demand of $140 billion, which will move the economy away from full employment, not toward it. This policy would not restore full employment.
2. Increase government expenditures by $80 billion and raise taxes by $80 billion:
- Increase government expenditures by $80 billion: The spending multiplier is 5, so this would increase aggregate demand by $400 billion (80 * 5 = 400).
- Raise taxes by $80 billion: The tax multiplier is -4, so this would decrease aggregate demand by $320 billion (80 * -4 = -320).
- Net effect: The total change is an increase in aggregate demand of $80 billion (400 – 320 = 80), which is exactly the required shift to restore full employment. This policy would restore full employment.
3. Increase taxes by $20 billion:
- Increase taxes by $20 billion: The tax multiplier is -4, so this would reduce aggregate demand by $80 billion (20 * -4 = -80).
- This policy would reduce aggregate demand, not increase it. Therefore, this policy would not restore full employment.
4. Increase government expenditures by $24 billion and raise taxes by $10 billion:
- Increase government expenditures by $24 billion: This would increase aggregate demand by $120 billion (24 * 5 = 120).
- Raise taxes by $10 billion: This would decrease aggregate demand by $40 billion (10 * -4 = -40).
- Net effect: The total change is an increase in aggregate demand of $80 billion (120 – 40 = 80), which is exactly what is needed to restore full employment. This policy would restore full employment.
5. Increase government expenditures by $16 billion:
- Increase government expenditures by $16 billion: This would increase aggregate demand by $80 billion (16 * 5 = 80).
- This policy would restore full employment.
Correct Answers:
- Increase government expenditures by $80 billion and raise taxes by $80 billion.
- Increase government expenditures by $24 billion and raise taxes by $10 billion.
- Increase government expenditures by $16 billion.