If the AD shortfall is $700 billion and the MPC is 0.95, Instructions: Enter your responses rounded to one decimal place. a. How large is the desired fiscal stimulus

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28-10-2020
Business

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If the AD shortfall is $700 billion and the MPC is 0.95, Instructions: Enter your responses rounded to one decimal place. a. How large is the desired fiscal stimulus

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amcool amcool · Answer 1 · 2020-10-31T01:52:50+01:00

Answer:

a. The desired fiscal stimulus is $35.0 billion.

b. The income tax cut is $36.8 billion.

c. The amount of government spending that would achieve the target is $35.0 billion.

Explanation:

Note: This question is not complete. The complete question is therefore provided before answering the question as follows:

If the AD shortfall is $700 billion and the MPC is 0.95, Instructions: Enter your responses rounded to one decimal place.

a. How large is the desired fiscal stimulus?

b. How large an income tax cut is needed?

c. Alternatively, how much government spending would achieve the target?

The explantion of the answers is now provided as follows:

From the question, we have:

Aggregate demand (AD) shortfall = $700 billion

Marginal Propensity to Consume (MPC) = 0.95

a. How large is the desired fiscal stimulus?

To calculate the the desired fiscal stimulus, we need to first calculate the multiplier as follows:

Multipliers = 1 (1 - MPC) ................... (1)

Substituting the value into equation (1), we have:

Multipliers = 1 (1 - 0.95) = 1 / 0.05 = 20

The formula for calculating the fiscal stimulus is as follows:

Fiscal stimulus = AD shortfall / Multiplier ..................... (2)

Substituting the values into equation (2), we have:

Fiscal stimulus = $700 billion / 20 = $35.0 billion.

Therefore, the desired fiscal stimulus is $35.0 billion.

b. How large an income tax cut is needed?

This can be calculated using the following formula:

Income tax cut = Fiscal stimulus / MPC .............. (3)

Substituting the values into equation (3), we have:

Income tax cut = $35 billion / 0.95 = $36.8421052631579 billion

Rounding to one decimal place, we have

Income tax cut = $36.8 billion

Therefore, the income tax cut is $36.8 billion.

c. Alternatively, how much government spending would achieve the target?

The amount of increase in government spending that would achieve the target is the same thing as the desired fiscal stimulus already obtained in part a above.

Therefore, the amount of government spending that would achieve the target is $35.0 billion.