Any Macroeconomics experts here?

[Schfifty Five]

Here is the question:

If APS is .2 and MPS is .10, a simultaneous increase in both taxes and government spending of $30 billion will:

(a) reduce consumption by $27B, increase government spending by $27B, and increase GDP by $30B

(b) reduce consumption by $27B, increase government spending by $27B, and increase GDP by $27B

(c) reduce consumption by $24B, increase government spending by $30B, and increase GDP by $30B

(d) reduce consumption by $24B, increase government spending by $24B, and increase GDP by $24B

The answer in the study guide is (a) and I understand the 1st and 3rd part of it, but I can't figure out the 2nd part. Why would government spending only increase by $27B and not $30B?

I've gone over and over the text book to try and figure this out but I just can't seem to find the reasoning.

If anyone can explain it to me, I'd be extremely grateful.

BTW, I have emailed my professor, but this is an online class and responses sometimes takes over a week to hear back.

 

[The-Noid]

Read about balanced budget multiplier, if you search google I believe the third or forth link works out a similar problem. I am on my bb so sorry I can't help more.

 

[Schfifty Five]

Originally posted by: Yoxxy
Read about balanced budget multiplier, if you search google I believe the third or forth link works out a similar problem. I am on my bb so sorry I can't help more.

morning bump.

Thanks for the advice. I am familiar with balanced budget and I believe that is what gives the answer to the 3rd part of the answer.

If taxes and government both increase the same amount, then real GDP output will increase by the same amount.

However, I'm still stumped as to why if government decides to spend $30B more, the answer says govt spending only goes up by $27B.

 

[The-Noid]

MPS is equal to .10 meaning 10% of the 30B will be saved. This money does not flow back into the economy. GDP increases because of the government or bb multiplier. The government only collects the 27B as the other .1 (Marginal Propensity of Savings) is saved.

You would not use the average propensity to save as the tax is implied to be based on your higher marginal income which is where MPS comes in.

Congrats on being an econ guy I haven't done it in a number of years but always loved econ not many econ majors left. Everyone wants to go into marketing and management which are the building blocks of nothing and you will get a job that is nothing more than being a yes man. Economics is the building blocks of law and finance.

 

[gsellis]

Originally posted by: Yoxxy
Congrats on being an econ guy I haven't done it in a number of years but always loved econ not many econ majors left. Everyone wants to go into marketing and management which are the building blocks of nothing and you will get a job that is nothing more than being a yes man. Economics is the building blocks of law and finance.

I was headed towards the Actuary/Econometrics/Decision Support (BA Wash U STL, was enrolled at UCF in Econometrics MAE before I got the current job, 21 years ago). Ended up in IT (and did do some DSS and Finance support modeling, SAS development).

:roll: Keynesian Macro equations... if it were so cut and dry (and correct). Never could explain stagflation with those equations (supply shock).

Good luck on the final!

 

[The-Noid]

Obama is attempting to obviously bring Classical(Renaissance)-Keynesian economics back. New-Keynesian has some merit in what is happening today, but I just simply can't believe how much government command is coming into the economy. I would like to see some sort of automatic stabilizers for when this recession is over, but instead we have years of budget deficits with no rollbacks on any government spending.

 

[Schfifty Five]

PM replied Yoxxy.

I really think the answer that the study guide shows has a typo. I think the $27B increase in Gov't spending should be $30B.

 

[The-Noid]

Sure makes sense here lets use real numbers:

3000B consumption 300B Savings, Government Spending 300B GDP 3300B. Tax Rate 10%.

Tax 30B = 27B Consumption Decrease, 3B Savings Decrease which mean tax base goes down as consumption has decreased. Now consumption is 2973, savings is 297 and government revenue decreased by 10% of the 30B or 3B.

Now government increases spending 30B to 327B and and the multiplier brings the spending up as the government does not save any of the 30B and it flows into the economy thus increasing GDP. My memory is hazy on the last part I just remember enough about government spending multipliers that it increases.

What I would say is that you know C and D aren't right as that is the APS and you can figure out B is not correct as the government multiplier is going to always GDP when tax comes in.

With the answers given you can always narrow the problem down.

 

[The-Noid]

Government spending goes down as consumption goes down so the tax base is also decreased on current taxes.