Suppose an economy is experiencing a recessionary gap equal to $10 billion.
a) If the government does nothing then use the AD/AS model to explain how the self-correcting mechanism will eliminate the gap.
b) If the marginal propensity to consume is .8 and the tax rate is .2 then use the AD/AS model and the multiplier to illustrate the impact of a $4 billion increase in government spending on real GDP and the price level. Determine whether or not the increase in spending will eliminate the recessionary gap.
c) Repeat part (b) except now suppose the government imposes a $4 billion cut to fixed taxes but leaves the tax rates the same at .20.
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