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Suppose the MPC is 0.60. Assume there are no crowding out or investment accelerator effects. If...

Suppose the MPC is 0.60. Assume there are no crowding out or investment accelerator effects. If the government increases expenditures by $200 billion, then by how much does aggregate demand shift to the right? If the government decreases taxes by $200 billion, then by how much does aggregate demand shift to the right?

A. $500 billion and $300 billion
B. $500 billion and $500 billion
C. $300 billion and $300 billion
D. $300 billion and $180 billion
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Answer #1

Answer: A. $500 billion and $300 billion

Given:

MPC = 0.60 and Government increases expenditures by $200 billion

Calculation:

Spending multiplier = 1 - MPC 1-0.60 = 2.5 0.4

Change in aggregate demand = Initial change in government spending * Spending multiplier

Change in aggregate demand = $200 * 2.5 = $500 billion

Aggregate demand shift to the right by $500 billion

----------------------------------------------------------------------------------------------------------------------------------------------------------------

Given:

MPC = 0.60 and Government decreases taxes by $200 billion

Calculation:

- MPC Tac multiplier == 1- MPC -0.60 1-0.60 -0.60 0.40 = (-)1.5

Change in aggregate demand = Initial change in government tax * Tax multiplier

Change in aggregate demand = $200 * (-) 1.5 = (-) $300 billion

Aggregate demand shift to the right by $300 billion

( Assume there are no crowding out or investment accelerator effects)

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