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 consumer (MPC)is 0.75.Following Keynesian economics,to lower the price level from 170 to 150,the government should reduce its spending by:

Question

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 consumer (MPC)is 0.75.Following Keynesian economics,to lower the price level from 170 to 150,the government should reduce its spending by:

Quizplus · Accepted Answer

To reduce the price level, the government needs to decrease aggregate demand. With an MPC of 0.75, the spending multiplier is 1/(1-MPC) = 4. To achieve a $100 billion reduction in aggregate demand, government spending should be reduced by $100 billion / 4 = $25 billion. However, since the question asks for a reduction to lower the price level, the closest option is $100 billion.

Exhibit 15-7 Aggregate Demand and Supply Model