AP® Macroeconomics · Free response

Closing a recessionary gap in Pellam with spending or taxes

write it first, then score yourself point by point

Short free-response question · four-function calculator · 5 points · about 12 minutes

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The question

Name: ______________________   Date: ____________   Closing a recessionary gap in Pellam with spending or taxes (5 points)

Pellam is an invented country whose real GDP is 200 billion dollars below full-employment output. Its marginal propensity to consume (MPC) is 0.8. Assume the price level does not change.

  1. (A) Calculate Pellam's spending multiplier. Show your work. [1 point]

  2. (B) Calculate Pellam's tax multiplier. Show your work. [1 point]

  3. (C) Calculate the change in government purchases that would close the gap, and state whether purchases must increase or decrease. Show your work. [1 point]

  4. (D) Suppose instead Pellam closes the gap with a change in taxes alone. Calculate the change in taxes needed, and state whether taxes must increase or decrease. Show your work. [1 point]

  5. (E) Explain why the tax cut in part D must be larger than the increase in government purchases in part C. [1 point]