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    Fiscal Policy Tools: Answers to Review Questions

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    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