Question

Suppose a hypothetical economy is currently in a recessionary gap of $64 billion. Four economists agree that expansionary fiscal policy can increase total spending and move the economy out of recession, but they are debating which type of expansionary policy should be used.
Economist A believes that the government spending multiplier is 8 and the tax multiplier is 2. Economist B believes that the government spending multiplier is 4 and the tax multiplier is 8.

Required:
Compute the amount the government would have to increase spending to close the output gap according to each economist's belief.

Answer 1

Answer:

a. Amount the government would have to increase spending according Economist A = $8 billion

b. Amount the government would have to increase spending according Economist B = $16 billion

Explanation:

a. Economist A

Since government spending multiplier is believed to be 8, this implies that the government has to spend an amount that when it is multiplied by 8 it will be equal to recessionary gap of $64 billion in order to close the output gap. This amount can be calculated as follows:

Amount the government would have to increase spending according Economist A = Amount of recessionary gap / Government spending multiplier according to Economist A = $64 billion / 8 = $8 billion

b. Economist B

Since government spending multiplier is believed to be 4, this implies that the government has to spend an amount that when it is multiplied by 4 it will be equal to recessionary gap of $64 billion in order to close the output gap. This amount can be calculated as follows:

Amount the government would have to increase spending according Economist B = Amount of recessionary gap / Government spending multiplier according to Economist B = $64 billion / 4 = $16 billion