Suppose the economy is in a recession. Policymakers estimate that aggregate demand is RM100 billion short...

 

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Suppose the economy is in a recession. Policymakers estimate that aggregate demand is RM100 billion short of the amount necessary to generate the long-run natural rate of output. That is, if aggregate demand were shifted to the right by RM100 billion, the economy would be in long-run equilibrium. a. If the government chooses to use fiscal policy to stabilize the economy, by how much should they increase government spending if the marginal propensity to consume (MPC) is 0.75 and there is no crowding out? (3 marks) b. If the government chooses to use fiscal policy to stabilize the economy, by how much should they increase government spending if the marginal propensity to consume (MPC) is 0.80 and there is no crowding out? (3 marks) c. If there is crowding out, will the government need to spend more or less than the amounts you found in (a) and (b) above? Why? (4 marks) d. If investment is very sensitive to changes in the interest rate, is crowding out more of a problem or less of a problem? Why? (4 marks) e. If policy makers discover that the lag for fiscal policy is two years, should that make them more likely to employ fiscal policy as a stabilization tool or more likely to allow the economy to adjust on its own? Why? (3 marks) Suppose the economy is in a recession. Policymakers estimate that aggregate demand is RM100 billion short of the amount necessary to generate the long-run natural rate of output. That is, if aggregate demand were shifted to the right by RM100 billion, the economy would be in long-run equilibrium. a. If the government chooses to use fiscal policy to stabilize the economy, by how much should they increase government spending if the marginal propensity to consume (MPC) is 0.75 and there is no crowding out? (3 marks) b. If the government chooses to use fiscal policy to stabilize the economy, by how much should they increase government spending if the marginal propensity to consume (MPC) is 0.80 and there is no crowding out? (3 marks) c. If there is crowding out, will the government need to spend more or less than the amounts you found in (a) and (b) above? Why? (4 marks) d. If investment is very sensitive to changes in the interest rate, is crowding out more of a problem or less of a problem? Why? (4 marks) e. If policy makers discover that the lag for fiscal policy is two years, should that make them more likely to employ fiscal policy as a stabilization tool or more likely to allow the economy to adjust on its own? Why? (3 marks)

Answer rating: 100% (QA)

a To determine how much government spending should be increased to shift aggregate demand by RM100 billion we can use the spending multiplier formula ... View the full answer