Question:
Economy is at Y = 3000. Full employment is at Y = 4000. MPS = 0.2. What policy achieves full employment?
(1) Inc G by 1000
(2) Inc G by 500
(3) Inc G by 250
(4) Dec taxes by 1000
(5) Dec taxes by 250
Correct Answer:
(5)
Answer Explanation:
The required change in GDP ($Delta Y$) is +1000. The tax multiplier is $-MPC/MPS$. Since MPS = 0.2, MPC = 0.8. Tax multiplier = $-0.8 / 0.2 = -4$. To find the required tax cut: $Delta Y = text{Multiplier} times Delta T rightarrow 1000 = -4 times Delta T rightarrow Delta T = -250$. The government must decrease direct taxes by Rs. 250 billion.
Topic: Fiscal Policy Year: 2017
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