In an economy, the government wants to decrease aggregate demand by $48 billion

Question

In an economy, the government wants to decrease aggregate demand by $48 billion at each price level to decrease real GDP and control demand-pull inflation. If the MPS is 0.25, then it could: A. Decrease government spending by $16 billion B. Increase taxes by $16 billion C. Decrease government spending by $10 billion D. Increase taxes by $24 billion In an economy, the government wants to decrease aggregate demand by $48 billion at each price level to decrease real GDP and control demand-pull inflation. If the MPS is 0.25, then it could: A. Decrease government spending by $16 billion B. Increase taxes by $16 billion C. Decrease government spending by $10 billion D. Increase taxes by $24 billion A. Decrease government spending by $16 billion B. Increase taxes by $16 billion C. Decrease government spending by $10 billion D. Increase taxes by $24 billion

Explanation / Answer

Option (B).

Spending multiplier = 1 / MPS = 1 / 0.25 = 4

To decrease aggregate demand by $48 billion, required decrease in government spending ($ Billion) = 48 / 4 = 12

Tax multiplier = - (1 - MPS) / MPS = - (1 - 0.25) / 0.25 = - 0.75 / 0.25 = - 3

To decrease aggregate demand by $48 billion, required increase in tax ($ Billion) = 48 / 3 = 16

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