Homework - Chapter 12 Key Questions #2, 3
#2) Assume that a hypothetical economy with an MPC of .8is experiencing severe recession. By how much would governmentspending have to increase to shift the aggregate demandcurve rightward by $25 billion? How large a tax cut would beneeded to achieve this same increase in aggregate demand?Why the difference? Determine one possible combination of government spending increases and tax decreases that would accomplishthis same goal.
To calculate the increase in government spending, the multiplier needs to be determined.
Multiplier = 1/ MPS (1-MPC)
= 1/.8
= 5 - and therefore the government spending = $5 billion
As the marginal propensity to consume is 0.8, only 80% of the tax will be spent and therefore
.8 x Tax Cut = 5 Billion
by solving for Tax Cut , Tax Cut = 6.25 Billion
The difference occurs because not all of the tax cut is spend, some is saved.
Possible Combination - $1 billion increase in gov. spending and $5 billion tax cut
#3) What are government’s fiscal policy options for endingsevere demand-pull inflation? Use the aggregate demand-aggregatesupply model to show the impact of these policies onthe price level. Which of these fiscal policy options do you thinka “conservative” economist might favor? A “liberal” economist?
Options are to : 1) reduce government spending 2) increase taxes
The person who wants to preserve the size of the government might opt for option 2 while the person who thinks the public sector is too large might opt for option 1.
Thursday, May 10, 2007
Sunday, May 6, 2007
ECON HOMEWORK
1) Weigh the two arguments regarding unemployment in Europe. Is unemployment high because of high because of high natural rates of unemployment or because of deficient aggregate demand?
The first argument claims that the unemployment in Europe is due to the natual rate of unemployment. Economists claim that these European nations have already reached full-employment, with only frictional and structural unemployment present. Thus, there is a high natural rate of unemployment due to the huge costs of hiring workers. The welfare benefits offered to the workers far exceed the benefits of working in some cases. The second argument claims that the unemployment in Europe is a result of a deficient aggregate demand. European governments , in fear of raising inflation rates, has not increased AD and thus the country is producing at an output less than the optimal point. The reason for unemployment in Europe is perhaps a combination between these two theories.
2) Explain the experience of the US between 1996 and 2000 when the economy was at greater than full employment with high GDP growth while maintaining low levels of inflation. What allowed this so-called "New Economy" to occur, and what brought it to an end in 2001?
This "New Economy" was perhaps brought to an end in 2001 because of 911.
The first argument claims that the unemployment in Europe is due to the natual rate of unemployment. Economists claim that these European nations have already reached full-employment, with only frictional and structural unemployment present. Thus, there is a high natural rate of unemployment due to the huge costs of hiring workers. The welfare benefits offered to the workers far exceed the benefits of working in some cases. The second argument claims that the unemployment in Europe is a result of a deficient aggregate demand. European governments , in fear of raising inflation rates, has not increased AD and thus the country is producing at an output less than the optimal point. The reason for unemployment in Europe is perhaps a combination between these two theories.
2) Explain the experience of the US between 1996 and 2000 when the economy was at greater than full employment with high GDP growth while maintaining low levels of inflation. What allowed this so-called "New Economy" to occur, and what brought it to an end in 2001?
This "New Economy" was perhaps brought to an end in 2001 because of 911.
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