40. You are given the following information about aggregate demand at the existi

Question

40. You are given the following information about aggregate demand at the existing price level for an economy: (1) consumption = $500 billion; (2) investment = $50 billion; (3) government purchases = $100 billion; and (4) net export = $20 billion. If the full-employment level of GDP for this economy is $620 billion, then what combination of actions would be most consistent with the goal of achieving price level stability? A. Increase government spending and taxes B. Decrease government spending and taxes C. Decrease government spending and increase taxes D. Increase government spending and decrease taxes

Explanation / Answer

Aggregate Demand is equal to C + I + G + X - M. So using the values from above; aggregate demand is equal to 500+50+100+20 = 670.

So aggregate demand is greater than GDP i.e 670>620. It means that people have more income and they are spending more so to achieve a stable price level , government should decrease spending and increase taxes.

( Increase in aggregate demand eventually lead to increase in prices so to control the demand govt decreases spending and increases taxes thereby reducing personal disposable income)

Option C.

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