The government wishes to reduce he price level by reducing real GDP by $400 billion. Assuming a tax multiplier of 4 and a government spending multiplier of 5, which of the following policy prescriptions would reduce the aggregate demand curve by $400 billion?

Question

The government wishes to reduce he price level  by reducing real GDP by $400 billion. Assuming a tax multiplier of 4 and a government spending multiplier of 5, which of the following policy prescriptions would reduce the aggregate demand curve  by $400 billion?

Quizplus · Accepted Answer

Decreasing government spending by $160 billion would directly reduce aggregate demand by $160 billion * 5 (government spending multiplier) = $800 billion. Decreasing taxes by $100 billion would increase aggregate demand by $100 billion * 4 (tax multiplier) = $400 billion. The net effect is a $400 billion reduction in aggregate demand ($800 billion - $400 billion), matching the government's goal.

The Government Wishes to Reduce He Price Level by Reducing