In a neoclassical economy, assume that the government lowers both government spending and taxes by $100 billion. If the marginal propensity to consume is 0.6, investment will:

Question

Quizplus · Accepted Answer

The decrease in government spending and taxes by $100 billion will reduce aggregate demand in the economy, causing a decrease in investment. However, the decrease in taxes will increase disposable income, leading to an increase in consumption. The change in investment will be equal to the change in aggregate demand multiplied by the marginal propensity to consume:

Change in investment = (-$100 billion) x 0.6 = -$60 billion

Therefore, investment will decrease by $60 billion. However, since the question asks for the change in investment, the answer is C, which represents the increase in investment required to offset this decrease. Investment will rise by $40 billion.

In a Neoclassical Economy, Assume That the Government Lowers Both