In a neoclassical economy, assume that the government lowers both government spending and taxes by $100 billion. If the marginal propensity to consume is 0.6, investment:

Question

Quizplus · Accepted Answer

In a neoclassical economy, the government lowering both spending and taxes by $100 billion will lead to a decrease in aggregate demand and a short-term decrease in output. As investment is a component of aggregate demand, it will also decrease. However, the marginal propensity to consume suggests that for every $1 decrease in income, consumption will decrease by $0.6. Therefore, the decrease in investment will not be as large ($100 billion x 0.4 = $40 billion). Therefore, if government spending and taxes are both lowered by $100 billion, investment will rise by $40 billion.

In a Neoclassical Economy, Assume That the Government Lowers Both