Workshop_6_HW_Problems_and_Answers

Workshop_6_HW_Problems_and_Answers - Workshop 6 HW Problems...

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Workshop 6 HW Problems and Answers 1. Suppose that the government increases its expenditures payments by $100 billion and pays for the increase by raising autonomous taxes by $100 billion. What is the effect on aggregate demand and real GDP of each change individually and of the two combined? The increase in government expenditure adds directly to aggregate demand so that aggregate demand and real GDP both increase. The increase in autonomous taxes indirectly decreases aggregate demand by decreasing consumption expenditure. The decrease in aggregate demand leads to a decrease in real GDP. The magnitude of the increase in aggregate demand from the increase in government expenditure exceeds the magnitude of the decrease from the increase in autonomous taxes. So when both effects are combined, on net aggregate demand increases so that real GDP increases. 1 1. Explain why higher marginal tax rates reduce the size of the government expenditure multiplier. The multiplier occurs because the initial increase in government expenditure increases people’s disposable incomes, which then leads to a further induced increase in consumption expenditure. Then, in turn, the induced increase in consumption expenditure increases other people’s disposable incomes, which then leads to another round of induced consumption expenditure. The induced increases in expenditure are what create the multiplier. Income taxes,
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Workshop_6_HW_Problems_and_Answers - Workshop 6 HW Problems...

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