In an economy, the government wants to decrease aggregate demand by $48 billion at each price level to decrease real GDP and control demand-pull inflation.If the MPS is .25, then it could:

Question

Quizplus · Accepted Answer

The MPC + MPS = 1, so if the MPS is 0.25, then the MPC is 0.75. The government wants to decrease aggregate demand by $48 billion, so we can use the formula:

Change in aggregate demand = -MPC x Change in disposable income

We can rearrange this formula to solve for the change in taxes, which is equal to the change in disposable income:

Change in taxes = -Change in aggregate demand / MPC

Plugging in the values, we get:

Change in taxes = -($48 billion) / 0.75 = -$64 billion

Since we want to decrease taxes, we need to reverse the sign to get a positive value:

Change in taxes = $64 billion

Since we want to decrease aggregate demand by $48 billion, we need to increase taxes by $48 billion. However, we calculated that we need to increase taxes by $64 billion, which is more than we need. Therefore, the best choice is to increase taxes by $16 billion, which is the closest to the desired target.

In an Economy, the Government Wants to Decrease Aggregate Demand