Suppose the MPC is .75.There are no crowding out or investment accelerator effects.If the government increases expenditures by $200 billion how far does aggregate demand shift? If the government decreases taxes by $200 billion how far does aggregate demand shift?
A)$800 billion and $800 billion
B)$800 billion and $600 billion
C)$600 billion and $600 billion
D)$600 billion and $450 billion

Question

Quizplus · Accepted Answer

If the MPC is .75, we can use the formula 1/1-MPC to determine the multiplier, which is 4. With no crowding out or investment accelerator effects, the government spending multiplier equals the tax multiplier.

Hence, if the government increases expenditures by $200 billion, aggregate demand will shift by 4 * $200 billion = $800 billion.

If the government decreases taxes by $200 billion, consumers will increase consumption spending (since the MPC is .75), which will in turn increase aggregate demand. The shift in aggregate demand will be 4 * $200 billion = $800 billion in total, but only $600 billion of this will be due to the tax cut itself ($200 billion multiplied by the MPC of .75). Therefore, the answer is B: $800 billion from the expenditure increase and $600 billion from the tax cut.

Suppose the MPC Is