Question

Cazenovia is in the midst of a bad? recession, and its Congress has placed economic recovery at the top of its political agenda. Different expansionary fiscal policies are currently being? examined, but members of Congress are aware of the problems associated with? large, sustained government deficits and will not accept any proposal that increases the deficit by more than
?$4 million.

After lengthy? discussions, these are the final? proposals:

Plan? A: Spend$4 million on highways

Plan? B: Reduce taxes by $4million

Assume the economy of Cazenovia is characterized by the following four equations in the short? run:

Y

?=

C? + I? + G? + NX

I

?=

I0

? (a constant)
C

?=

C0

? +
CY?(Yminus?T?)

NX

?=

0

where
C0

? =
4040

and
CY

? =
0.750.75.

Using the government expenditure multiplier from the simple model presented in the? chapter, the plan to spend

?$4 million on highways will increase Y? (GDP) by ?$___ million.? (click the following icon for help answering this? question)

Using the government taxation multiplier from the simple model presented in the? chapter, the plan to reduce taxes by

?$4 million will increase Y? (GDP) by

?$____ million. ? (click the following icon for help answering this? question)

LOADING...

The plan that appears to be the most effective in achieving? Congress's goal is to? ____________.

A.

reduce taxes by

?$44

million.

B.

spend

?$44

million on highways.

C.

both are equally effective.

D.

neither achieves the goal of Congress.

Answer 1

Answer:

1. $ 16 million

2. $ 12 million

3. B. spend ?$4 million on highways.

Explanation:

1. Change in Y = Change in G/(1 - MPC) = 4million/(1 - 0.75) = $ 16 million

Y increases by $ 16 million.

2. Change in Y = - MPC x Change in Taxes/(1 - MPC) = - 0.75 x - 4 million/0.25 = $ 12 million

Decrease in taxes increases Y by $ 12 million.

3. B. spend ?$4 million on highways.

This increases output by more amount.