Chapter 12 Key Questions #2,3

2. Assume that a hypothetical economy with an MPC of .8 is experiencing severe recession. By how much would governmentspending have to increase to shift the aggregate demandcurve rightward by $25 billion? How large a tax cut would beneeded to achieve this same increase in aggregate demand?Why the difference? Determine one possible combination of government spending increases and tax decreases that would accomplishthis same goal.

Multiplier = 1/ MPS (1-MPC)
= 1/.8
= 5 (billion)
tax * 0.8 = 5 (billion)
tax cut = 6.25 (billion)
Government can either increase spending by 1 billion, or cut taxes by 5 billion

3. What are government’s fiscal policy options for endingsevere demand-pull inflation? Use the aggregate demand-aggregatesupply model to show the impact of these policies onthe price level. Which of these fiscal policy options do you thinka “conservative” economist might favor? A “liberal” economist?

The government can either increase the taxes, or decrease government spending. A Conservative economist would most likely increase taxes, while a Liberal economist would most likely decrease the government spending in this situation.