Suppose that income taxes are increased by $600 billion. If the marginal propensity to consume is 0.75 and the spending multiplier is 4, by how much will the aggregate demand curve shift at a given price level?

Question

Quizplus · Accepted Answer

The formula for the spending multiplier is: 1/(1-MPC). 
Thus, the spending multiplier in this case is 4/(1-0.75) = 16. 
Therefore, the aggregate demand curve will shift leftward by: 
$600 billion x 16 = $9,600 billion. 
However, the question asks how much the curve will shift at a given price level, so we need to divide by the price level. 
Assuming the price level remains constant, the aggregate demand curve will shift leftward by: 
$9,600 billion / 4 = $2,400 billion. 
Therefore, the answer is B.

Suppose That Income Taxes Are Increased by $600 Billion