In a certain year the aggregate amount demanded at the existing price level consists of $100 billion of consumption, $40 billion of investment, $10 billion of net exports, and $20 billion of government purchases.Full-employment GDP is $120 billion.To obtain price level stability under these conditions the government should:
A)increase tax rates and reduce government spending.
B)discourage personal saving by reducing the interest rate on government bonds.
C)increase government expenditures.
D)encourage private investment by reducing corporate income taxes.

Question

Quizplus · Accepted Answer

The total aggregate demand in the economy (consumption + investment + net exports + government purchases = $100 + $40 + $10 + $20 = $170 billion) exceeds the full-employment GDP ($120 billion), indicating an inflationary gap. To close this gap and achieve price level stability, the government should decrease aggregate demand, which can be achieved by reducing government spending and increasing taxes. This will reduce disposable income and decrease consumption, investment, and government purchases. Therefore, option A is the best choice.

In a Certain Year the Aggregate Amount Demanded at the Existing