Exhibit 11-2 Aggregate demand and supply model Suppose the economy in Exhibit 11-2 is in equilibrium at point E₁ and the marginal propensity to consume (MPC) is 0.75. Following Keynesian economics, the federal government can move the economy to full employment at point E₂ by: A) decreasing government tax revenue by approximately $33 billion. B) decreasing government tax revenue by $750 billion. C) increasing government tax revenue by $100 billion. D) increasing government tax revenue by approximately $33 billion.

Question

Quizplus · Accepted Answer

According to the AD-AS model, to move the economy from point E₁ to point E₂, the aggregate demand must increase. One way to increase aggregate demand is by decreasing taxes, which will increase disposable income and therefore consumption. The government would need to decrease tax revenue by an amount that would increase aggregate demand by enough to close the output gap and reach full employment. Using the MPC of 0.75, the tax cut needed would be approximately $33 billion. Therefore, choice A is the best answer.

Exhibit 11-2 Aggregate Demand and Supply Model