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8 marksBasic Keynesian Models

CAPE Economics Unit 2 · 2006 · Paper 2 · Question 3(b)(i)

An economy has equilibrium income/output of 900 billion, a desired target output of 1100 billion, marginal propensity to consume of 0.75, and taxes held constant.

Explain how the government can use fiscal policy (taxing and spending) to increase the equilibrium level of output from 900 billion to 1100 billion.

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Other parts of this question

  1. 3(a)(i)Differentiate between 'discretionary fiscal policy' and 'automatic stabilizers'.[6 marks]
  2. 3(a)(ii)Using examples, explain how discretionary fiscal policy and automatic stabilizers work during periods of recession or inflation in an economy.[6 marks]
  3. 3(b)(ii)Using a 45° line diagram, graph the original situation and the solution identified in (b)(i).[10 marks]
  4. 3(c)Suppose the government finances the increase in government spending with an equal increase in taxes to maintain a balanced budget. Explain what happens to…[10 marks]
  5. 3(d)(i)What is the balanced budget multiplier?[4 marks]
  6. 3(d)(ii)Referring to the solution in (c), how large is the balanced budget multiplier? Explain your answer.[6 marks]

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