If the AD excess is 300 billion and the MPC is 075 a How muc

If the AD excess is $300 billion and the MPC is 0.75, (a) How much fiscal restraint is desired? (b) By how much do income taxes have to be increased to get that restraint?

Solution

AD excess = $300 billion

MPC = 0.75

Calculate Valur of Multiplier -

Multiplier = 1/1-MPC = 1/1-0.75 = 4

The value of multiplier is 4.

(a) Calculate Desired fiscal restraint -

Desired fiscal restraint = AD excess/Multiplier = $300 billion/4 = $75 billion.

Fiscal restraint of $75 billion is desired.

(b) Calculate desired increase in income taxes to get desired fiscal restraint -

Desired increase in income taxes = Desired fiscal restraint/MPC = $75 billion/0.75 = $100 billion

Income taxes have to be increased by $100 billion to get the desired fiscal restraint.