Question

If the MPS in an economy is .4, government could shift the aggregate demand curve leftward...

If the MPS in an economy is .4, government could shift the aggregate demand curve leftward by $30 billion by:

A) reducing government expenditures by $125 billion.
B) reducing government expenditures by $20 billion.
C) increasing taxes by $50 billion.
D) increasing taxes by $250 billion.
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Answer #1

Change in GDP or Y = Change in Government spending/MPS

- $ 30 billion = Change in G/0.4

Change in G = - 30 billion x 0.4 = - 12 billion

This means reducing government expenditure by 12 billion causes AD curve leftward by 30 billion.

Change in GDP or Y = - MPC x Change in Taxation/MPS

- 30 billion = - (1 - MPS) x Change in Taxation/0.4

- 12 billion = - (0.6) x Change in Taxation

Change in Taxation = 12 billion/0.6 = 20 billion

This means increase in taxes by $ 20 billion causes AD to shift leftwards by $ 30 billion.

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