Short Answer 
A recessionary output gap indicates underperformance of an economy, requiring government intervention to close the gap between Real GDP and Potential GDP. To achieve this, an increase in government expenditure of $20 billion or a tax cut of $25 billion can be implemented, though government spending is generally deemed more effective.
Step 1: Understand the Recessionary Output Gap
A recessionary output gap occurs when the country’s *Real GDP* is less than its *Potential GDP*. This indicates that the economy is underperforming and not reaching the full employment level of output. The difference between the potential output and the current output represents the gap that needs to be closed.
Step 2: Calculate the Required Changes in Government Expenditure
To close the output gap, the government can increase its expenditure. For Newland, a proposed increase of *$20 billion* is calculated using the *government spending multiplier*. With a marginal propensity to consume (MPC) of *0.8*, the spending multiplier is derived as follows:
- Government spending multiplier = 1 / (1 – MPC) = 5
- Gap to be closed = 500 – 400 = 100
- Required increase in government expenditure = 100 / 5 = $20 billion
Step 3: Determine the Impact of Tax Changes
Alternatively, the government can affect the output gap through tax cuts. The necessary reduction in taxes to achieve the same outcome is calculated using the *tax multiplier*. Here, a figure of *$25 billion* is needed, computed as follows:
- Tax multiplier = MPC / (1 – MPC) = 4
- Decrease in tax required = Gap to be closed / Tax multiplier = 100 / 4 = $25 billion
However, it is noted that increasing government spending tends to be more effective for closing the output gap than reducing taxes.