Question 1 (fiscal stimulus). The government can stimulate the economy via fiscal policies. However, not all policies are equally efficient, and the exact policy to be enacted depends on the purpose. This question tries to discuss some of the nuances. Fiscal stimulus can happen in many ways such as direct investment, taxes cuts, etc. For simplicity, in this question, we will only consider the simplest type of policy which is to directly give people money — similar to the stimulus checks handed out by the U.S. federal government during COVID. The aspect we want to think about is who to give the money to. Suppose the U.S. population consists of poor people, middle-class people, and rich people. Suppose there are only three kinds of consumption: food, housing, and diamonds.
Let’s introduce a new concept called “marginal propensity to consume” (MPC)
A person’s MPC is defined as “how much one spends each additional dollar of income”. For instance, if for every dollar of income given to me, I spend 70 cents, then my MPC is 70%.
(a) (1 point)
Please compute the MPC for the poor, the middle-class, and the rich using the information below:1A. For every dollar given to the poor, they spend 70 cents on food, 25 cents on housing, and save the rest.
2A. For every dollar given to the middle-class, they spend 40 cents on food, 40 cents on housing, and save the rest.
3A. For every dollar given to the rich, they spend 5 cents on food, 15 cents on housing, 30 cents on diamonds, and save the rest.
Now, please compute the MPC for the poor, the middle-class, and the rich.
b) Suppose the government has a fixed amount of money to give, and it can only give money to one of the three populations.
i. Suppose the government’s goal is to increase consumption as much as possible without regard to what is being consumed.
Who should the government give the money to, and why?ii. Suppose the government’s goal is to stimulate housing consumption as much as possible.
Who should the government give the money to, and why?
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