For a real Keynesian model of a mixed economy with a marginal propensity to consume equal to .8 and autonomous consumption equals 600 billion, planned investment equals 100 billion, government spending equals 300 billion, and taxes equal 300 billion:

a. Calculate the equilibrium level of Ye or real output.

b. Draw a diagram that illustrates the equilibrium condition for the model, the equilibrium level of output, and the level of autonomous spending. Be sure to carefully label your diagram, including the axes and the slopes of the lines you draw.

c. Troubled by a persistent recession gap of S200b, government authorities decide to cut taxes to close the recession gap.   By how much should they cut taxes to close the recession gap?

d.   Now illustrate the effect of the tax cut you recommended in an intermediate-range IS/LM diagram. Be sure to illustrate the original equilibrium level of output and the full employment level of output and the effect of your recommended tax cut.

e. Further research reveals that the change in taxes that you recommended to increase real output has driven up real interest rates from 2% to 3%. Those higher real interest rates reduced investment by $25b.

Calculate the effect of the decline in investment on Ye (equilibrium level of output after your tax cut) and illustrate your answer in your IS/LM diagram being sure to indicate the full multiplier, investment crowding out, and the net multiplier.

f. Finally, calculate the net multiplier and the size tax cut would be necessary to close the recessionary after taking into account the effect of investment crowding out.

Answer rating: 100% (QA)

a The equilibrium level of real output Ye can be calculated using the Keynesian Cross model where Ye ... View the full answer