Suppose a country decreases income taxes by $300 billion, and this leads to an increase in...
Suppose a country decreases income taxes by $300 billion, and this leads to an increase in consumption spending of $150 billion. Suppose the multiplier is 1.5 and the economy’s real GDP is $5,000 billion.
- In which direction will the aggregate demand curve shift and by how much?
Homework Answers
Taxes are reduced by 300 billion. Consumption is increased by 150 million. This implies that disposable income is increased by 300 billion and so MPC = 150/300 = 0.5. Now tax multiplier is -MPC/(1-MPC) = -0.5/(1-0.5) = -1. Hence, when taxes are reduced by 300 billion, income or real GDP will also increase by 300 x 1 = 300 billion. Aggregate demand curve shift to the right when taxes are reduced and the size of shift is 300 billion.
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