8. Problems and Applications Q8 is no crowding out, and the marginal propensity

Question

8. Problems and Applications Q8 is no crowding out, and the marginal propensity to consume is 3/4. The initial effect of the tax reduction is a $ is a s billion decrease in aggregate demand. The total effect of the tax cut on aggregate demand billion The total effect of this $20 billion tax cut is the total effect that a 20 billion increase in government purchases would be. How could the government increase a regate demand without changing the government's budget deficit? O Increase taxes and government purchases by the same amount 0 Decrease taxes and increase government purchases O Decrease taxes and government purchases by the same amount

Explanation / Answer

1) The initial effect of the tax deduction is a $15 billion increase in aggregate demand. The total effect of the tax cut on aggregate demand is $60 billion
Working: $20 billion * 3/4 = $15 billion
Multiplier : 1/(1-3/4) = 4; Total effect = $15 billion * 4 = 60 billion

2) The total effect of this $20 billion tax cut is $80 billion, the total effect that a $20 billion increase in government purchase would be.
Working: Total effect = $20 billion * 4 = 80 billion

3) How could government increase aggregate demand without changing the government's budget deficit
Solution: Increase taxes and government purchases by the same amount.
Explanation: The government could increase taxes by the same amount it increases. government purchases result to a bigger effect on output than a tax cut does.

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