In the simple Keynesian model (no money market)assume that equilibrium output falls short of potential output by 300 units and the MPC = 0.8.The size of the tax cut needed to reach full employment is
A)30.
B)60.
C)75.
D)300.

Question

Quizplus · Accepted Answer

To reach full employment, the government needs to increase aggregate demand. The multiplier (1/(1-MPC)) is 1/(1-0.8) = 5. To close a gap of 300 units, the required fiscal stimulus divided by the multiplier equals the output gap: Fiscal Stimulus = Output Gap / Multiplier. Therefore, Fiscal Stimulus = 300 / 5 = 60. However, a tax cut is less effective than government spending because only a portion (MPC) of the tax cut translates into spending. So, the required tax cut = Fiscal Stimulus / MPC = 60 / 0.8 = 75.

In the Simple Keynesian Model (No Money Market)assume That Equilibrium