The equilibrium level of output in the economy of Goata is $4,000 billion. Econo

Question

The equilibrium level of output in the economy of Goata is $4,000 billion. Economic data indicate that full-employment output is $4,500 billion and that an increase in aggregate demand to $4,800 billion is needed to eliminate the cyclical unemployment that exists. The marginal propensity to consume is 0.8


Advisors propose an increase in government purchases of $160 billion and a tax increase of $160 billion to eliminate the recessionary gap and prevent an increase in the budget deficit. Opponents correctly point out that:


A. The tax increase is not large enough to close the recessionary gap because taxes influence both consumption and saving.

B.The correct policy to eliminate a recessionary gap is to cut government purchases and cut taxes by $160 billion each.

C.The increase in taxes combined with the rise in government purchases would overstimulate demand and cause demand-pull inflation.

D. The tax increase would cause consumption to decline and offset the stimulus provided by the increase in government purchases enough to prevent closing the recessionary gap.

Please help me with some explanation for the answer

Explanation / Answer

Cutting taxes will give people more money but the likey case is that the economy is in a recession thus people tend to save. So they will save the extra cash and this will not increase demand. Hence, C is an answer

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