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Fiscal Policy Tools: Answers to Review Questions

1. In the tax cut example on pages 236-37 (see the attached file),
( a ) By how much does consumer saving increase initially?
( b ) How large is the initial spending injection?

2. Suppose the consumption function is
C = $400 billion + 0.8Y
and the government wants to stimulate the economy. By how much will aggregate demand at current prices shift initially (before multiplier effects) with
( a ) A $50 billion increase in government purchases?
( b ) A $50 billion tax cut?
( c ) A $50 billion increase in income transfers?
What will the cumulative AD shift be for
( d ) The increased G?
( e ) The tax cut?
( f ) The increased transfers?

3. Suppose the government decides to increase taxes by $20 billion and to increase Social Security benefits by the same amount. How will this combined tax transfer policy affect aggregate demand at current prices?

5. If the AD shortfall is $600 billion and the MPC is 0.9,
( a ) How large is the desired fiscal stimulus?
( b ) How large an income tax cut is needed?
( c ) Alternatively, how much more government spending would achieve the target?

6. If the AD excess is $300 billion and the MPC is 0.8,
( a ) How much fiscal restraint is desired?
( b ) By how much do income taxes have to be increased to get that restraint?

7. ( a ) According to the News on page 238, how much more did the average household spend on appliances, electronics, and furniture when it received the 2008 tax rebate?
( b ) If all 110 million households did so, how much did aggregate consumption increase?
( c ) If the MPC was 0.75, how much would cumulative spending increase as a result?

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Solution Preview

a) Saving increases by MPS x the tax cut
b) The initial spending injection is MPC x the tax cut

a) AD will initially increase by $50 billion
b) AD will initially increase by ...

Solution Summary

This solution gives the answers to common Macroeconomics questions involving fiscal policy. The topics covered include:
- fiscal stimulus
- tax cuts
- Social Security
- the 2008 tax rebate