Question

Suppose the economy is in recession. Policymakers estimate that aggregate demand is $100 billion short of the amount necessary to generate the long run natural rate of output. That is, if aggregate demand were shifted to the right by $100 billion, the economy would be in long run equilibrium. a.Explain the impact on the economy if the government chooses to use fiscal policy to stabilize the economy and the marginal propensity to consume (MPC) is given as 0.75 with no crowding out. b.If there is a crowding out effect and investment is very sensitive to changes in the interest rate, should the government increase spending more or less than this amount? 

          Suppose the economy is in recession. Policymakers estimate that aggregate demand is $100 billion short of the amount necessary to generate the long run natural rate of output. That is, if aggregate demand were shifted to the right by $100 billion, the economy would be in  long run equilibrium. 
a.Explain the impact on the economy if the government chooses to use fiscal policy to stabilize  the economy and the marginal propensity to consume (MPC) is given as 0.75 with no crowding  out. 
b.If there is a crowding out effect and investment is very sensitive to changes in the interest rate,  should the government increase spending more or less than this amount?
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Principles of Economics
Principles of Economics
Gregory Mankiw 8th Edition
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Suppose the economy is in recession. Policymakers estimate that aggregate demand is $100 billion short of the amount necessary to generate the long run natural rate of output. That is, if aggregate demand were shifted to the right by $100 billion, the economy would be in long run equilibrium. a.Explain the impact on the economy if the government chooses to use fiscal policy to stabilize the economy and the marginal propensity to consume (MPC) is given as 0.75 with no crowding out. b.If there is a crowding out effect and investment is very sensitive to changes in the interest rate, should the government increase spending more or less than this amount?
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Suppose the economy is in recession. Policymakers estimate that aggregate demand is $100 billion short of the amount necessary to generate the long run natural rate of output. That is, if aggregate demand were shifted to the right by $100 billion, the economy would be in long run equilibrium. a.Explain the impact on the economy if the government chooses to use fiscal policy to stabilize the economy and the marginal propensity to consume (MPC) is given as 0.75 with no crowding out. b.If there is a crowding out effect and investment is very sensitive to changes in the interest rate, should the government increase spending more or less than this amount?

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An economy is operating with output $200 billion below its natural rate, and fiscal policymakers want to close this recessionary gap. The central bank agrees to adjust the money supply to hold the interest rate constant, so there is no crowding out. The marginal propensity to consume is 0.75, and the price level is completely fixed in the short-run. (a) In what direction and by how much would government spending need to change to close the recessionary gap? (b). If the central bank were to hold the money supply, rather than the interest rate, constant in response to the change in fiscal policy, would your answer to (a) be larger, smaller, or the same?

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Transcript

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00:01 Here we have aggregate demand of $100 billion.
00:08 We're given the marginal propensity to consume the mpc is 0 .75.
00:14 So first we're going to determine the multiplier, and the multiplier is calculated by taking 1 divided by 1 minus mpc.
00:26 Using substitution, this gives us 1 over 1 minus 0 .75, 1 over 1 .5, 1 over 1 .1 .5.
00:37 1 minus 0 .75 is 0 .25, and 1 over 0 .25 is 4...
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