Given the necessary increase in GDP of $500 and the MPC of $0.90, how much should we reduce the taxes to get GDP to its natural state?
To determine the amount by which taxes should be reduced to increase GDP by $500, we can use the spending multiplier formula, which is equal to 1 / (1 - MPC).
The spending multiplier determines how much a change in autonomous spending (such as tax reduction) can affect GDP.
In this case, the MPC is given as 0.90, meaning that for every additional dollar of income, people spend 90% and save 10%.
To calculate the spending multiplier, we can use the formula:
Spending Multiplier = 1 / (1 - MPC)
= 1 / (1 - 0.90)
= 1 / 0.10
= 10
Now, we know that the desired increase in GDP is $500. By using the spending multiplier, we can determine the amount of tax reduction required to achieve this increase:
Tax Reduction = Desired Increase in GDP / Spending Multiplier
= $500 / 10
= $50
Therefore, to get GDP to its natural state with the given increase of $500 and an MPC of 0.90, we should reduce taxes by $50.
To calculate the amount by which taxes should be reduced to achieve the desired increase in GDP, you need to use the formula for the expenditure multiplier. The expenditure multiplier is calculated as 1 divided by the marginal propensity to consume (MPC). In this case, the MPC is given as 0.90.
The expenditure multiplier formula is:
Expenditure Multiplier = 1 / (1 - MPC)
Substituting the given MPC value:
Expenditure Multiplier = 1 / (1 - 0.90)
= 1 / 0.10
= 10
Now that we have the expenditure multiplier, we can calculate the change in aggregate demand (ΔAD) using the following formula:
ΔAD = Expenditure Multiplier * ΔTaxes
Here, ΔTaxes represents the change in taxes. We are trying to find the value of ΔTaxes that will result in a $500 increase in GDP.
ΔAD = $500
Using the formula above, we can rearrange it to solve for ΔTaxes:
ΔTaxes = ΔAD / Expenditure Multiplier
= $500 / 10
= $50
Therefore, to achieve a $500 increase in GDP, you would need to reduce taxes by $50.
To calculate the tax reduction needed to achieve the necessary increase in GDP, we can use the formula for the fiscal multiplier. The fiscal multiplier is the ratio of the change in GDP to the change in government spending or taxes.
The formula for the fiscal multiplier is:
Fiscal Multiplier = 1 / (1 - MPC)
In this case, the MPC (Marginal Propensity to Consume) is given as 0.90. Let's calculate the fiscal multiplier:
Fiscal Multiplier = 1 / (1 - 0.90) = 1 / 0.10 = 10
Now, we can determine the tax reduction needed to achieve the desired increase in GDP using the fiscal multiplier:
Tax Reduction = Necessary Increase in GDP / Fiscal Multiplier
Tax Reduction = $500 / 10 = $50
Therefore, to get GDP to its natural state with a necessary increase of $500 and an MPC of 0.90, the taxes should be reduced by $50.