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5. Show why a $10 billion reduction in government purchases of goods and services will have a larger effect on real GDP than a $10 billion reduction in government transfers by completing the accom- panying table for an economy with a marginal propensity to consume (MPC) of 0.6. The first and second rows of the table are filled in for you: on the left side of the table, in the first row, the $10 billion reduction in government purchases decreases real GDP and disposable income, YD, by $10 billion, lead- ing to a reduction in consumer spending of $6 billion Rounds 1 2 3 4 5 6 7 8 9 10 Decrease in G=-$10 billion (billions of dollars) Change in real GDP Change in G or C AG= $10.00 AC = -6.00 AC = ? AC = ? AC = ? AC = ? AC = AC = AC = AC= ? ? ? ? -$10.00 -6.00 ? ? ? ? ? ? ? ? Change in YD -$10.00 -6.00 ? ? ? ? ? ? ? ? Change in TR or C ATR=-$10.00 AC = AC = AC = AC = AC = AC = AC = AC = AC = (MPC x change in disposable income) in row 2. How- ever, on the right side of the table, the $10 billion reduction in transfers has no effect on real GDP in round 1 but does lower YD by $10 billion, resulting in a decrease in consumer spending of $6 billion in round 2. -6.00 ? ? ? ? ? ? ? ? a. When government purchases decrease by $10 billion, what is the sum of the changes in real GDP after the 10 rounds? b. When the government reduces transfers by $10 bil- lion, what is the sum of the changes in real GDP after the 10 rounds? Decrease in TR=-$10 billion (billions of dollars) c. Using the formula for the multiplier for changes in government purchases and for changes in trans- fers, calculate the total change in real GDP due to the $10 billion decrease in government purchases and the $10 billion reduction in transfers. What explains the difference? [Hint: The multiplier for government purchases of goods and services is 1/(1-MPC). But since each $1 change in govern- ment transfers only leads to an initial change in real GDP of MPC × $1, the multiplier for govern- ment transfers is MPC/(1- MPC).] Change in real GDP $0.00 -6.00 ? ? ? ? ? ? ? ? Change in YD -$10.00 -6.00 ? ? ? ? ? ? ? ?

5. Show why a $10 billion reduction in government purchases of goods and services will have a larger effect on real GDP than a $10 billion reduction in government transfers by completing the accom- panying table for an economy with a marginal propensity to consume (MPC) of 0.6. The first and second rows of the table are filled in for you: on the left side of the table, in the first row, the $10 billion reduction in government purchases decreases real GDP and disposable income, YD, by $10 billion, lead- ing to a reduction in consumer spending of $6 billion Rounds 1 2 3 4 5 6 7 8 9 10 Decrease in G=-$10 billion (billions of dollars) Change in real GDP Change in G or C AG= $10.00 AC = -6.00 AC = ? AC = ? AC = ? AC = ? AC = AC = AC = AC= ? ? ? ? -$10.00 -6.00 ? ? ? ? ? ? ? ? Change in YD -$10.00 -6.00 ? ? ? ? ? ? ? ? Change in TR or C ATR=-$10.00 AC = AC = AC = AC = AC = AC = AC = AC = AC = (MPC x change in disposable income) in row 2. How- ever, on the right side of the table, the $10 billion reduction in transfers has no effect on real GDP in round 1 but does lower YD by $10 billion, resulting in a decrease in consumer spending of $6 billion in round 2. -6.00 ? ? ? ? ? ? ? ? a. When government purchases decrease by $10 billion, what is the sum of the changes in real GDP after the 10 rounds? b. When the government reduces transfers by $10 bil- lion, what is the sum of the changes in real GDP after the 10 rounds? Decrease in TR=-$10 billion (billions of dollars) c. Using the formula for the multiplier for changes in government purchases and for changes in trans- fers, calculate the total change in real GDP due to the $10 billion decrease in government purchases and the $10 billion reduction in transfers. What explains the difference? [Hint: The multiplier for government purchases of goods and services is 1/(1-MPC). But since each $1 change in govern- ment transfers only leads to an initial change in real GDP of MPC × $1, the multiplier for govern- ment transfers is MPC/(1- MPC).] Change in real GDP $0.00 -6.00 ? ? ? ? ? ? ? ? Change in YD -$10.00 -6.00 ? ? ? ? ? ? ? ?

ECON MACRO
ECON MACRO
5th Edition
ISBN:9781337000529
Author:William A. McEachern
Publisher:William A. McEachern
Chapter11: Fiscal Policy
Section: Chapter Questions
Problem 1.6P
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5. Show why a $10 billion reduction in government purchases of goods and services will have a larger effect on real GDP than a $10 billion reduction in government transfers by completing the accom- panying table for an economy with a marginal propensity to consume (MPC) of 0.6. The first and second rows of the table are filled in for you: on the left side of the table, in the first row, the $10 billion reduction in government purchases decreases real GDP and disposable income, YD, by $10 billion, lead- ing to a reduction in consumer spending of $6 billion Rounds 1 2 3 4 5 6 7 8 9 10 Decrease in G=-$10 billion (billions of dollars) Change in real GDP Change in G or C AG = -$10.00 AC = AC = AC = AC = AC = AC = AC = AC = AC = -6.00 ? ? ? ? ? ? ? ? -$10.00 -6.00 ? ? ? ? ? ? ? ? Change in YD -$10.00 -6.00 ? ? ? ? ? ? ? ? Change in TR or C ATR=-$10.00 AC = AC = AC = AC = AC = AC = AC = AC = AC = (MPC x change in disposable income) in row 2. How- ever, on the right side of the table, the $10 billion reduction in transfers has no effect on real GDP in round 1 but does lower YD by $10 billion, resulting in a decrease in consumer spending of $6 billion in round 2. -6.00 ? ? ? ? ? ? ? ? a. When government purchases decrease by $10 billion, what is the sum of the changes in real GDP after the 10 rounds? b. When the government reduces transfers by $10 bil- lion, what is the sum of the changes in real GDP after the 10 rounds? Decrease in TR -$10 billion (billions of dollars) c. Using the formula for the multiplier for changes in government purchases and for changes in trans- fers, calculate the total change in real GDP due to the $10 billion decrease in government purchases and the $10 billion reduction in transfers. What explains the difference? [Hint: The multiplier for government purchases of goods and services is 1/(1-MPC). But since each $1 change in govern- ment transfers only leads to an initial change in real GDP of MPC × $1, the multiplier for govern- ment transfers is MPC/(1-MPC).] Change in real GDP $0.00 -6.00 ? ? ? ? ? ? ? ? Change in YD -$10.00 -6.00 ? ? ? ? ? ? ? ?
Transcribed Image Text:5. Show why a $10 billion reduction in government purchases of goods and services will have a larger effect on real GDP than a $10 billion reduction in government transfers by completing the accom- panying table for an economy with a marginal propensity to consume (MPC) of 0.6. The first and second rows of the table are filled in for you: on the left side of the table, in the first row, the $10 billion reduction in government purchases decreases real GDP and disposable income, YD, by $10 billion, lead- ing to a reduction in consumer spending of $6 billion Rounds 1 2 3 4 5 6 7 8 9 10 Decrease in G=-$10 billion (billions of dollars) Change in real GDP Change in G or C AG = -$10.00 AC = AC = AC = AC = AC = AC = AC = AC = AC = -6.00 ? ? ? ? ? ? ? ? -$10.00 -6.00 ? ? ? ? ? ? ? ? Change in YD -$10.00 -6.00 ? ? ? ? ? ? ? ? Change in TR or C ATR=-$10.00 AC = AC = AC = AC = AC = AC = AC = AC = AC = (MPC x change in disposable income) in row 2. How- ever, on the right side of the table, the $10 billion reduction in transfers has no effect on real GDP in round 1 but does lower YD by $10 billion, resulting in a decrease in consumer spending of $6 billion in round 2. -6.00 ? ? ? ? ? ? ? ? a. When government purchases decrease by $10 billion, what is the sum of the changes in real GDP after the 10 rounds? b. When the government reduces transfers by $10 bil- lion, what is the sum of the changes in real GDP after the 10 rounds? Decrease in TR -$10 billion (billions of dollars) c. Using the formula for the multiplier for changes in government purchases and for changes in trans- fers, calculate the total change in real GDP due to the $10 billion decrease in government purchases and the $10 billion reduction in transfers. What explains the difference? [Hint: The multiplier for government purchases of goods and services is 1/(1-MPC). But since each $1 change in govern- ment transfers only leads to an initial change in real GDP of MPC × $1, the multiplier for govern- ment transfers is MPC/(1-MPC).] Change in real GDP $0.00 -6.00 ? ? ? ? ? ? ? ? Change in YD -$10.00 -6.00 ? ? ? ? ? ? ? ?
Expert Solution
Introduction

Aggregate Demand: Aggregate demand in an economy is the sum of private consumption expenditure (C), private investment expenditure (I), government expenditure and the net exports (exports - Imports). 

 

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