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Show why a $10 billion decrease in government purchases will have a larger e?ect on real GDP than a $10 billion reduction in government transfers by completing the table for an economy with a marginal propensity to consume (MPC) of 0.6. The ?rst and second rows of the table are ?lled in for you: in the ?rst row, the $10 billion decrease in government purchases decreases real GDP and disposable income, YD, by $10 billion, leading to a decrease in consumer spending of $6 billion (MPC x change in disposable income) in row 2. However, the $10 billion reduction in transfers has no e?ect on real GDP in round 1 but does lower YD by $10 billion, resulting in a decrease in consumer spending of $6 billion in round 2.
1. When government purchases decrease by $10 billion, what is the sum of the changes in real GDP after the 10 rounds?
2. When the government reduces government transfers by $10 billion, what is the sum of the changes in real GDP after the 10 rounds?
3. Using the formula for the multiplier for changes in government purchases and for changes in transfers, calculate the total change in real GDP due to the $10 billion decrease in government purchases and the $10 billion reduction in government transfers. What explains the di?erence?
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