Suppose that when income taxes are reduced by $400 billion, households increase consumption Jby 80% of the resulting change in disposable income. Suppose also that the multiplier is 2. At a given price level, the aggregate demand curve shifts to the right by

Question

Quizplus · Accepted Answer

The formula for the spending multiplier is:
Multiplier = 1 / (1 - MPC)
Where MPC is the marginal propensity to consume, which is given as 0.8 in this case:
Multiplier = 1 / (1 - 0.8) = 1 / 0.2 = 5

Next, we need to calculate the total increase in aggregate demand:
Total increase = 5 x $400 billion = $2 trillion

Finally, we need to subtract the initial government spending cut of $400 billion to find the net increase in aggregate demand:
Net increase = $2 trillion - $400 billion = $1.6 trillion

Therefore, the aggregate demand curve shifts to the right by $1.6 trillion, which is equivalent to $640 billion. So the correct answer is C) $640 billion.

Suppose That When Income Taxes Are Reduced by $400 Billion