Exhibit 15-7 Aggregate demand and supply model Suppose the economy in Exhibit 15-7 is in equilibrium at point E₁ and the marginal propensity to consume ( MPC ) is 0.75. Following Keynesian economics, to lower the price level from 170 to 150 the government should raise taxes by:

Question

Quizplus · Accepted Answer

According to the Keynesian economics, to reduce the price level, the government needs to reduce aggregate demand. This can be achieved by either reducing government spending or raising taxes. Using the formula ΔY = ΔC/(1-MPC), where ΔY is the change in equilibrium output and ΔC is the change in consumption, we can calculate the change in taxes required to decrease the price level.

ΔY = 0 (since we want to stay at the same equilibrium level of output)
ΔC = -20 (since a decrease in the price level will lead to a decrease in consumption)
MPC = 0.75

0 = -20/(1-0.75)
0 = -80
ΔT = $133 billion

Therefore, the government should raise taxes by $133 billion to decrease the price level from 170 to 150. Choice C is the correct answer.

Exhibit 15-7 Aggregate Demand and Supply Model Suppose the Economy