You are hired by the Bureau of Economic Analogies (BEA) as an economic consultant. The Chairperson of the BEA tells you that he believes the current unemployment rate is too low. The unemployment rate can be increased if aggregate output decreases. He wants to know what policy to pursue to decrease aggregate output by $50 billion. The best estimate he has for the MPC is 0.9. Which of the following policies should you recommend?

Question

Quizplus · Accepted Answer

CTo decrease aggregate output by $50 billion with an MPC (marginal propensity to consume) of 0.9, the government needs to either decrease its spending or increase taxes, but in a way that leverages the multiplier effect. The multiplier is calculated as 1/(1-MPC), which in this case is 1/(1-0.9) = 10. Therefore, to decrease aggregate output by $50 billion, the government needs to decrease its spending or increase taxes by $50 billion / 10 = $5 billion. Both decreasing government spending by $5 billion (A) and increasing taxes by $5 billion (C) would achieve this goal through the multiplier effect.

You Are Hired by the Bureau of Economic Analogies (BEA)