If the absolute value of the tax multiplier equals 1.6,real GDP is $13 trillion,and potential real GDP is $13.4 trillion,then taxes would need to be cut by ________ to restore the economy to potential real GDP.
A)$250 billion
B)$400 billion
C)$640 billion
D)None of the above are correct.Taxes should be increased in this case.

Question

Quizplus · Accepted Answer

The tax multiplier effect indicates how much GDP changes in response to a change in taxes. With an absolute value of the tax multiplier of 1.6, a $1 change in taxes leads to a $1.6 change in GDP. To close a $0.4 trillion (or $400 billion) GDP gap, taxes need to be cut by the amount that, when multiplied by 1.6, equals $400 billion. Therefore, $400 billion / 1.6 = $250 billion.

If the Absolute Value of the Tax Multiplier Equals 1