# Taxes and imports, and the multiplier model

A. Marginal propensity to expend is 0.5 and there is a recessionary gap of $200. What fiscal policy would you recommend?

b. Why does cutting taxes by $100 have a smaller effect in GDP than increasing expenditures by $100?

a. Suppose imports were a function of disposable income instead of income. What would be the new multiplier? How does it compare with the multiplier when imports were a function of income?

b. Explain why making taxes and imports endogenous reduces the multiplier?

State how the following information changes the slope of the AD curve.

a. The effect of price level changes on autonomous expenditures is reduced.

b. The size of the multiplier increases.

c. Autonomous expenditures increase by $20

d. Falls in the price level disrupt financial markets which offset the normally assumed effects of a change in the price level.

a. Your employer offers you a choice of two bonus packages: $1,400 today or $2,000 five years from now. Assuming a 6 percent rate of interest, which is the better value? Assuming an interest rate of 10 percent, which is the better value?

b. Suppose the price of a one-year 10 percent coupon bond with a $100 face value of $98. Are market interest rates likely to be above or below 10 percent? Explain. What is the bond's yield or return? If market interest rates fell, what would happen to the price of the bond?

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#### Solution Preview

a. Marginal propensity to expend is 0.5 and there is a recessionary gap of $200. What fiscal policy would you recommend?

The multiplier is 1/1-.5 = 1/.5 = 2. Increasing government spending by $100 would therefore close the gap.

b. Why does cutting taxes by $100 have a smaller effect in GDP than increasing expenditures by $100?

Because people do not spend all of each dollar people recieve cutting taxes is less effective. People would spend only up to the MPC, so for each $1 in tax cuts perhaps only 80 cents would be spent. With increasing expenditures, all of the money immediately increases GDP.

a. Suppose imports were a function of disposable income instead of income. What would be the new multiplier? How does it compare with the multiplier when imports were a function of income?

We model the multiplier as M = 1 / [1 - (1- MPS +MPM)(1 - MPT)] where MPM is the ...

#### Solution Summary

Taxes and imports, and the multiplier model