Suppose the government, in an effort to avoid an increase in the deficit, votes for a budget neutral tax cut policy. Assume the marginal propensity to consume (MPC) is equal to 0.85 and taxes are cut by $8 billion. Round answers to the nearest billion, and specify decreases as a negative number.
A. By how much will government spending change?
B. What is the resulting change in the equilibrium level of real GDP?

PART A:

The government has voted for budget neutral tax cut policy in order to avoid the enhancement in the deficit. Thereby, government spending will be reduced by an amount of $8 billion.  

PART B:

The calculation for fall in GDP is as follows:  

Multiply with change in government expenditure,

Thus, if the government expense is reduced by $8 billion then fall in GDP is by $53.33 billion  

EFFECT ON GDP DUE TO REDUCTION OF TAX:

Multiply with change in tax,

Thus, when the taxes are reduced by $8 billion, then GDP shows an increase by $45.33 billion.

Therefore, change in equilibrium level of real GDP = -$8 billion ( -53.33 billion + 45.33 billion).  

rational decision making is a multi-step process for making choices between alternatives. the process of rational decision making favors logic, objectivity, and analysis over subjectivity and insight. the word “rational” in this context does not mean sane or clear-headed as it does in the colloquial sense.

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