Figure 3-7

-In Figure 3-7 above,if natural real GDP = $2500,AP = $250,and the change in "a" = change in I = change in NX = 0,the tax cut required to achieve then natural real GDP is

Question

Figure 3-7
 
-In Figure 3-7 above,if natural real GDP = $2500,AP = $250,and the change in "a" = change in I = change in NX = 0,the tax cut required to achieve then natural real GDP is

Quizplus · Accepted Answer

From Figure 3-7, we know that the initial equilibrium GDP is below the natural real GDP, so there is a recessionary gap. To close this gap and achieve the natural real GDP, we need to increase aggregate demand. Since AP is given as $250, the only way to increase aggregate demand is by reducing taxes (since the other variables that affect AD are constant). The tax cut required can be calculated as follows:

Multiplier = 1/(1 - MPC) = 1/(1 - 0.8) = 5
Tax cut required = (Multiplier x Recessionary Gap)/AP
                  = (5 x ($2500 - $2250))/$250
                  = $312.50

Therefore, the tax cut required to achieve the natural real GDP is $312.50, which is option A.

Figure 3-7 -In Figure 3-7 Above,if Natural Real GDP = $2500,AP =