Question

You are hired by the Council of Economic Advisors (CEA) as an economic consultant. The chairperson of the CEA tells you that she believes the current unemployment rate is too high. The unemployment rate can be reduced if aggregate output increases. She wants to know what policy to pursue to increase aggregate output by exist300 billion. The best estimate she has for the MPC is 0.8. Which of the following policies should you recommend?

A. Reduce government spending by exist300 billion and increase taxes by exist300 billion.
B. Decrease both government spending and taxes by exist300 billion.
C. Increase both government spending and taxes by exist300 billion.
D. Increase government spending by exist300 billion and reduce taxes by exist300 billion.

Answer 1

Answer:

The correct answer is option C. Increase both government spending and taxes by exist300 billion.

Explanation:

Expenditure multiplier = 1 / (1 - MPC) = 5

Tax multiplier = - MPC / (1 - MPC) = -4

Change in multiplier = (300*5) +(-4*300)

                                 = 1500 - 1200

                                  = 300 billion

Therefore,there should be increase in  both government spending and taxes by exist 300 billion.