ECON: MACRO4
4th Edition
ISBN: 9781305436862
Author: William A. McEachern
Publisher: Cengage Learning
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Chapter 11, Problem 1.7PA
To determine
The impact of tax cut on the recessionary gap.
Concept Introduction:
Fiscal Policy: Fiscal policy is the policy by which government regulates the nation’s economy by adjusting the government spending and controlling the tax rates. It tries to influence the
Recessionary Gap: Recessionary Gap is the gap between actual output and potential output under full employment situation when actual output is less than potential output.
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Exercise 6
Imagine that you head production of a multinational food processing company. The ongoing uncer-
tainty about costs means that you are unsure of the future cost of one of your inputs, x2. Your firm's
production function is
y = f(x1, x2) = x²x²²
The output price p is 1000, x1 = 27, and wx₁ = 60.
1. Suppose the current input price is Wx2
=
50. Solve for the optimal choice of x2.
2. Now suppose that the probability the input price remains 50 is 0.65 and the probability that
Wx2
60 is 0.35. Solve for the optimal choice of x2. Round down to the nearest integer.
=
3. Finally, suppose the costs do actually rise, i.e., Wx2 = 60. Calculate the difference in profit from
the uncertainty in (2) vs. the certainty in (1).
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