Use the following Situation to answer the question : situation 20-2 Assume a closed economy. Suppose that autonomous consumption equals $400, planned investment equals $500, government expenditure equals $200, net taxes equals $50, and the mpc equals 0.9.
-Using the information in situation 20-2,if government increases their spending by $50 and increases net taxes by 50,then equilibrium aggregate output will change by
A)-$100.
B)-$50.
C)$50.
D)$100.

Question

Quizplus · Accepted Answer

The government is increasing its spending by $50, which will increase aggregate demand by a multiplier effect. The multiplier effect is 1/(1-mpc) = 1/(1-0.9) = 10. Therefore, the increase in government spending will increase aggregate demand by $500 (multiplier effect of $50 x 10). However, net taxes are also increasing by $50, which will decrease disposable income, and therefore consumption. The decrease in consumption will decrease aggregate demand by a multiplier effect. The multiplier effect is -mpc/(1-mpc) = -0.9/(1-0.9) = -9. Therefore, the increase in net taxes will decrease aggregate demand by $450 (multiplier effect of -$50 x -9). The overall effect on equilibrium aggregate output will be an increase of $50 ($500 increase in government spending minus $450 decrease in net taxes).

Use the Following Situation to Answer the Question : Situation