You are given the following information about aggregate demand at the existing price level for an economy: (1) consumption = $400 billion; (2) investment = $40 billion; (3) government purchases = $90 billion; and (4) net export = $25 billion. If the full-employment level of GDP for this economy is $600 billion, then what combination of actions would be most consistent with closing the GDP-gap here?
A) Increase government spending and taxes
B) Decrease government spending and taxes
C) Decrease government spending and increase taxes
D) Increase government spending and decrease taxes

Question

Quizplus · Accepted Answer

The GDP-gap in this economy is $600 billion - ($400 billion + $40 billion + $90 billion + $25 billion) = $45 billion. To close this gap, there needs to be an increase in aggregate demand. The most effective way to do this is to increase government spending and decrease taxes, which would increase both government purchases and disposable income for households, leading to an increase in consumption and therefore aggregate demand. Option A would decrease aggregate demand and option B would have a neutral effect on aggregate demand. Option C would decrease both government purchases and disposable income for households, leading to a decrease in aggregate demand. Therefore, the best choice is D.

You Are Given the Following Information About Aggregate Demand at the Existing