Answer and Explanation:
According to the scenario, computation of the given data are as follows:-
a). Because of the recession in economy American firms started decreases their business investment its indicate slowdown to the economy and less spending of the money by people because of the unemployment. To stimulate the economy the government has to increase the government spending and cut down their taxes. So because of this reason the federal budget will be deficit.
B) Increase In GDP Needed is
= Potential GDP - Real GDP Drop
= $1200 Billion - $800 Billion
= $400 Billion
Marginal Propensity to Consume(MPC) = .75
As we know that
Marginal Propensity to Save(MPS) = 1 - MPC
= 1 - 0.75
= 0.25
And,
Multiplier of Government Spending = 1 ÷ MPS
= 1 ÷ 0.25
= 4
Minimum Change in Government Spending is
= Increase in GDP Needed ÷ Multiplier of Government Spending
= $400 Billion ÷ 4
= $100 Billion
Therefore the government spending should be increased by $100 billion
c) Tax Multiplier is
= - Marginal Propensity to Consume(MPC) ÷ Marginal Propensity to Save(MPS)
= -0.75 ÷ 0.25
= -3
Minimum Change in Personal Income Tax
= Increase in GDP Needed ÷ Tax Multiplier
= $400 billion ÷ -3
= $133.33 billion
For closing the recessionary gap tax collection should be decrease by $133.33 billion.
d) The change in real interest rates will caused by either of the action in part B generate deficits and this deficits has financed by loans. example-additional borrowing increase the demand of loanable funds, which will increase interest rates.
