Answer Happy

Practice Questions from Chapter 21: Government Spending and Tax Multiplier on the Aggregate Demand 1. Suppose the economy is in a recession. The government chooses to use fiscal policy to address the situation. You are told that the government increased government spending by $10 billion, and that the marginal propensity to consume (MPC) is 0.75. a. What is the size (in S) of the initial effect of the spending on aggregate demand? b. Suppose the first recipient spends 0.75 of this spending in goods and services, and the second recipient does the same thing, and so on and so forth. Calculate the total effect on aggregate demand (hint: use spending multiplier formula). c. Suppose that instead of increasing government spending, the government chose to cut taxes by $10 billion. The size of the initial effect on AD is $ What is the total increase in AD? d. Which one has a larger effect on AD: tax cuts or government spending? (hint: The reason is because one of them has a larger initial effect).