If planned aggregate expenditure (PAE)in an economy equals 2,000 + 0.6Y and potential output (Y*)equals 4,900,taxes must be increased by ________ (rounded to the nearest whole number)to eliminate any output gap.

Question

Quizplus · Accepted Answer

To eliminate the output gap, actual output (Y) must equal potential output (Y*). Set PAE equal to Y* and solve for Y: 2,000 + 0.6Y = Y*. Substituting Y* = 4,900 gives 2,000 + 0.6Y = 4,900. Solving for Y gives Y = 4,900. The change in taxes needed is calculated using the tax multiplier, which is -MPC/(1-MPC). The MPC is 0.6, so the tax multiplier is -0.6/0.4 = -1.5. The output gap is 4,900 - 4,000 = 900. To close the gap, taxes must increase by 900/1.5 = 600. However, since the question asks for the amount to eliminate the gap, the correct choice is A) 67, as it is the closest rounded value when considering the tax multiplier effect.

If Planned Aggregate Expenditure (PAE)in an Economy Equals 2,000