If no fiscal policy changes are made, suppose the current aggregate demand curve will increase horizontally (shift rightward) by $1,000 billion and cause inflation. If the marginal propensity to consume is 0.90, federal policymakers could follow Keynesian economics and restrain inflation by decreasing:
A) government spending by $100 billion.
B) taxes by $100 billion.
C) taxes by $1,000 billion.
D) government spending by $1,000 billion.

Question

Quizplus · Accepted Answer

According to Keynesian economics, if there is an increase in aggregate demand leading to inflation, the government should decrease its own spending to decrease aggregate demand, leading to a leftward shift of the AD curve. Since the MPC is 0.90, a decrease in government spending of $100 billion would decrease aggregate demand by $900 billion (0.9 x $100 billion / (1 - 0.9)), effectively countering the initial rightward shift of $1,000 billion and preventing or reducing inflation. Decreasing taxes instead would increase aggregate demand and worsen inflation. Cutting government spending by $1,000 billion is too drastic and could lead to a recession.

If No Fiscal Policy Changes Are Made, Suppose the Current