QuestionJune 23, 2025

Suppose that the economy is in a long-run equilibrium at a price level of 100 and full-employment real GDP of 600 billion. An expansion occurs resulting from a 80 billion increase in aggregate demand. In order to restore the economy to full employment given a MPC of 0.80, taxes would need to: increase by 50 billion. increase by 20 billion. decrease by 20 billion. decrease by 50 billion.

Suppose that the economy is in a long-run equilibrium at a price level of 100 and full-employment real GDP of 600 billion. An expansion occurs resulting from a 80 billion increase in aggregate demand. In order to restore the economy to full employment given a MPC of 0.80, taxes would need to: increase by 50 billion. increase by 20 billion. decrease by 20 billion. decrease by 50 billion.
Suppose that the economy is in a long-run equilibrium at a price level of 100 and full-employment real GDP
of 600 billion. An expansion occurs resulting from a 80 billion increase in aggregate demand. In order to
restore the economy to full employment given a MPC of 0.80, taxes would need to:
increase by 50 billion.
increase by 20 billion.
decrease by 20 billion.
decrease by 50 billion.

Solution
4.2(284 votes)

Answer

Increase by \ 100 billion. Explanation 1. Determine the Multiplier The spending multiplier is calculated as \frac{1}{1 - \text{MPC}}. Given MPC = 0.80, the multiplier is \frac{1}{1 - 0.80} = 5. 2. Calculate Required Change in GDP The increase in aggregate demand is \ 80 billion, so the change in GDP is 80 \times 5 = \ 400 billion. 3. Calculate Tax Multiplier The tax multiplier is -\frac{\text{MPC}}{1 - \text{MPC}} = -\frac{0.80}{0.20} = -4. 4. Determine Required Change in Taxes To offset a \ 400 billion increase in GDP, taxes must change by \frac{400}{4} = \ 100 billion. 5. Determine Direction of Tax Change Since the tax multiplier is negative, to decrease GDP by \ 400 billion, taxes must increase by \ 100 billion.

Explanation

1. Determine the Multiplier<br /> The spending multiplier is calculated as $\frac{1}{1 - \text{MPC}}$. Given MPC = 0.80, the multiplier is $\frac{1}{1 - 0.80} = 5$.<br /><br />2. Calculate Required Change in GDP<br /> The increase in aggregate demand is $\$ 80$ billion, so the change in GDP is $80 \times 5 = \$ 400$ billion.<br /><br />3. Calculate Tax Multiplier<br /> The tax multiplier is $-\frac{\text{MPC}}{1 - \text{MPC}} = -\frac{0.80}{0.20} = -4$.<br /><br />4. Determine Required Change in Taxes<br /> To offset a $\$ 400$ billion increase in GDP, taxes must change by $\frac{400}{4} = \$ 100$ billion.<br /><br />5. Determine Direction of Tax Change<br /> Since the tax multiplier is negative, to decrease GDP by $\$ 400$ billion, taxes must increase by $\$ 100$ billion.
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