Please help!!!! i need little help in economics

Question

If real GDP is $570 billion, full employment GDP is $300 billion, and the marginal propensity to consume is 0.9, then Congress should

increase taxes by $20 billion.

increase taxes by $30 billion.

increase taxes by $270 billion.

increase spending by $27 billion.

decrease spending by $270 billion

please explain how you got your answer!!!

Answer 1

GAP is:

Current GDP - Full Employment GDP = 570 - 300 = $270 billion (above potential level)

So gov should reduce RGDP by $270 billion

Assume there is no crowding-out effect (simple linear Keynesian cross model), then multipliers will be:

ΔY/ΔG = 1/ (1-MPC) = 1/(1-0.9) = 1/ 0.1 = 10

ΔG = ΔY/10

ΔY/ΔT = -MPC / (1-MPC) = -0.9 / (1-0.9) = -0.9/ 0.1 = -9

ΔT = ΔY/ -9

ΔY = $ - 270 billion

ΔT = - 270 / -9 = $ +30 billion

ΔG = - 270 / 10 = $ -27 billion

From given list only "increase taxes by $30 billion." fits this condition, thus right answer is:

B: increase taxes by $30 billion.

Answer 2

Here is a simpler explanation with the same answer. You can see you need to decrease the GDP by $270 billion because it is above full employment levels. The multiplier is 10 because 1/MPS is the multiplier, and MPS is .1 Since a decrease in spending by $27 billion isn't a choice, you need to look at increases in taxes. However, when increasing taxes only the part that is spent counts on the multiplier, not the part which is saved by households. If you increase taxes by $30 billion then only $27 billion of that would have been spent. THe other $3 billion would have been saved, so the fact that the government now has it makes no difference. The government has essentially prevented $27 billion from being spent, so with the multiplier it has reduced the real GDP by $270 billion.