In an economy, the government wants to decrease aggregate demand by $24 billion at each price level to decrease real GDP and control demand-pull inflation.If the MPC is .75, then it could increase taxes by:
A)$6 billion.
B)$8 billion.
C)$10 billion.
D)$12 billion.

Question

Quizplus · Accepted Answer

The government can decrease aggregate demand by decreasing government spending or increasing taxes. Here, since the government wants to decrease aggregate demand by $24 billion, increasing taxes is a viable solution.

To find the amount of tax increase, we can use the formula:
Change in GDP = -MPC x Change in Taxes

We know that the change in GDP is -$24 billion and the MPC is 0.75.

Substituting the values, we get:
-$24 billion = -0.75 x Change in Taxes

Solving for Change in Taxes, we get:
Change in Taxes = -$24 billion / (-0.75)
Change in Taxes = $32 billion

Therefore, the government could increase taxes by $32 billion to decrease aggregate demand by $24 billion. However, the question asks for the amount by which taxes should be increased, not the total amount. So the answer would be $8 billion, which is a reduction of aggregate demand by $24 billion ($8 billion x 0.75 = $24 billion).

In an Economy, the Government Wants to Decrease Aggregate Demand