Macro3B Essay Example | Topics and Well Written Essays - 1000 words

Macro3B - Essay Example The expenditure multiplier is a constant that gives the value (a ratio) to what you will put in the economy and what you will get out of it as a result. It is an increased (multiplied) value because once money comes into the economy; it changes many hands and gradually multiplies. We first need to know the value of the multiplier before determining the amount by which we ought to increase government spending. Multiplier = 1 / MPS We know what the MPC is because MPC + MPS = 1 We can find out the value of MPS that is: 0.8 + MPS = 1 MPS = 1 – 0-.8 MPS = 0.2 Since MPS = 0.2, Multiplier = 1 / MPS Multiplier = 1 / 0.2 Multiplier = 5 At present, the economy lacks behind full employment by $2000 as the full employment level is $10,000 and we are currently at $8,000 (10,000 – 80000), to fulfill this gap, we will not increase government spending by 2000 as that would increase the total output to a large extent owing to the presence of the Expenditure multiplier, therefore we woul d increase it by: 2000 / Multiplier 2000 / 5 = $400 A $400 increase in Government spending would automatically trigger an increase of $2000 in the economy owing to the presence of the multiplier (i.e. 400 * 5 = $2000) Question 2: The other aspect of Fiscal tool that the government has on its disposal is the â€Å"taxes† which it can alter depending on the state of the economy. Since the President has asked me to work on the fiscal measure owing to popular public demand, we can work with it as well. First of all, it is important to understand that taxes are not a direct component of the GDP unlike government expenditure; they influence consumption. Also, tax cuts are feared to be saved to an extent depending on the public’s expectations (example, if there is more employment in the economy, GDP is likely to rise greatly, however, decreases in tax rates might even be saved by the households), therefore, the value of the tax multiplier is less than that of the expenditure multiplier; which means I would have to reduce taxes to a greater extent as compared to government expenditure to get the $2000 increase in GDP. Tax Multiplier: MPC / MPC Since MPC = 0.8 and MPS = 0.2 Tax Multiplier = 0.8 / 0.2 Tax Multiplier = 4 (Which is one less than the expenditure multiplier that was â€Å"5†) For the economy to boost to full employment, tax cuts would have to be given in accordance with the multiplier: 2000 / Tax Multiplier 2000/4 = $500 Therefore, it is evident, for the economy to go to the full employment level of $10,000, tax cuts worth 500 have to be given (which are 100 more than the expenditure if the government were to use that). This makes the government spending policy more attractive as compared to giving tax incentives to people. Question 3: If the president were to match increases in federal government expenditures with the offsetting increases in taxation, it would never give out a balanced budget. It is important to note that because of a leakage i.e. saving, a tax cut never gives out its full multiplier effect; tax cuts affect consumption and are not a direct part of the GDP. On the other hand, government expenditure is direct component of GDP as shown: Taking closer looks at the formula of tax multiplier (i.e. MPC/MPS) and comparing it to the expenditure multiplier, one would realize that the tax multiplier would always be â€Å"1† less than the government expenditure multiplier; therefore equal increases or decreases in both would not give out a balanc