Question

Suppose that the national economy is experiencing a recession with an estimated recessionary gap of $10 billion. Congress is considering the use of fiscal policy to ease the recession, and due to current political sentiments, it has determined that the maximum spending increase the government is willing to support is $3 billion. The government wants to make up the remainder of the recessionary gap using tax cuts. If a spending increase of $3 billion is approved and the MPC is 0.6, by how much will taxes need to be reduced to close the remainder of the recessionary gap

Answer 1

The tax that needs to be reduced is $ 4.66 billion

Further Explanation

The amount (Deflationary / recessionary) gap = $10 billion - 3 billion = 7 billion$

Keynesian Spending Multiplier from government spending

k = $\frac{1}{1-MPC} = \frac{1}{1-0.6} = \frac{1}{0.4} = 2.5 or \frac{1}{MPS}$

Tax Multiplier from tax

t = $\frac{MPC}{1-MPC} = \frac{0.6}{1-0.6} = \frac{0.6}{0.4} = 1.5 or \frac{MPC}{MPS}$

Option 1: Increased government spending (Loosening / Expansionary Fiscal Policy) by

GovSpending (Gs) = $\frac{Gap}{k} = \frac{7 billion}{2.5} = 2.8 billion$

Option 2: Tax is reduced by (-)

Tax = $\frac{Gap}{t}$ = $\frac{7 billion}{1.5} = 4.66 billion$

In economics, deflation is a period in which prices generally fall and the value of money increases. Deflation is the opposite of inflation. If inflation occurs due to a large amount of money circulating in the community, deflation occurs due to a lack of money in circulation. One way to overcome deflation is to reduce interest rates.

In the macroeconomy, a recession is a condition when the gross domestic product (GDP) decreases or when real economic growth is negative for two quarters or more in one year. Recession can result in a simultaneous decline in all economic activities such as employment, investment, and corporate profits. Recession is often associated with falling prices (deflation), or, conversely, sharply rising prices (inflation) in a process known as stagflation. The economic recession that lasts long is called economic depression. The drastic decline in the level of the economy (usually due to severe depression, or due to hyperinflation) is called economic bankruptcy (economic collapse). Columnist Sidney J. Harris distinguishes the above terms in this way: "A recession is when a neighbor loses a job; depression is when you lose a job."

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Deflationary brainly.com/question/13135934

To Reduce Tax brainly.com/question/13135934

Details

Class: College

Subject: Business

Keywords: Deflationary, tax, recessionary