Consider a hypothetical closed economy in which the marginal propensity to consume (MPC) is 0.8 and taxes do not vary with income (that is, taxes are fixed rather than variable and the income tax rate = 0). The following graph shows the aggregate demand curves (AD and AD₂), the short-run aggregate supply (AS) curve, and the long-run aggregate supply curve at the potential GDP level. The economy is currently at point A. PRICE LEVEL 128 ལྕ་སྐྱ་སྐྱ་སྐྱ་རྩ་སྐྱ 124 120 A 116 112 108 200 300 400 Potential GDP AS124 AD₂ AD₁ 500 600 700 800 900 1000 REAL GDP (Billions of dollars) The economy is currently experiencing a recessionary gap of $100 billion. To close this gap, one option would be for the government to increase not change). government purchases by $20 billion (assuming net taxes do If the government kept its purchases constant, it could also close the gap by (Hint: In this case, since taxes do not vary with income, the formula for the multiplier for a change in fixed taxes is net taxes (taxes minus transfers) by s -MPC .) 1-MPC billion.

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Chapter1: Making Economics Decisions
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Consider a hypothetical closed economy in which the marginal propensity to consume (MPC) is 0.8 and taxes do not vary with income (that is,
taxes are fixed rather than variable and the income tax rate = 0). The following graph shows the aggregate demand curves (AD and AD₂), the
short-run aggregate supply (AS) curve, and the long-run aggregate supply curve at the potential GDP level. The economy is currently at point A.
PRICE LEVEL
128
ལྕ་སྐྱ་སྐྱ་སྐྱ་རྩ་སྐྱ
124
120
A
116
112
108
200
300
400
Potential GDP
AS124
AD₂
AD₁
500
600 700
800
900
1000
REAL GDP (Billions of dollars)
The economy is currently experiencing a recessionary gap of $100 billion.
To close this gap, one option would be for the government to increase
not change).
government purchases by
$20 billion (assuming net taxes do
If the government kept its purchases constant, it could also close the gap by
(Hint: In this case, since taxes do not vary with income, the formula for the multiplier for a change in fixed taxes is
net taxes (taxes minus transfers) by s
-MPC
.)
1-MPC
billion.
Transcribed Image Text:Consider a hypothetical closed economy in which the marginal propensity to consume (MPC) is 0.8 and taxes do not vary with income (that is, taxes are fixed rather than variable and the income tax rate = 0). The following graph shows the aggregate demand curves (AD and AD₂), the short-run aggregate supply (AS) curve, and the long-run aggregate supply curve at the potential GDP level. The economy is currently at point A. PRICE LEVEL 128 ལྕ་སྐྱ་སྐྱ་སྐྱ་རྩ་སྐྱ 124 120 A 116 112 108 200 300 400 Potential GDP AS124 AD₂ AD₁ 500 600 700 800 900 1000 REAL GDP (Billions of dollars) The economy is currently experiencing a recessionary gap of $100 billion. To close this gap, one option would be for the government to increase not change). government purchases by $20 billion (assuming net taxes do If the government kept its purchases constant, it could also close the gap by (Hint: In this case, since taxes do not vary with income, the formula for the multiplier for a change in fixed taxes is net taxes (taxes minus transfers) by s -MPC .) 1-MPC billion.
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