Question

 The graph below depicts an economy where a decline in aggregate demand has caused a recession. Assume the government

 decides to conduct fiscal policy by changing taxes to reduce the burden of this recession.

 Instructions: Enter your answers as a whole number. If you are entering any negative numbers be sure to include a negative sign (-) in

 front of those numbers.

 a. How much does aggregate demand need to change to restore the economy to its long-run equilibrium?

 b. If the MPC is 0.75, how much do taxes need to change to shift aggregate demand by the amount you found in part a?

 Suppose instead that the MPC is 0.8.

c. How much does aggregate demand and taxes need to change to restore the economy to its long-run equilibrium?

 Aggregate demand needs to change by $_______ billion and taxes need to change by $_______ billion.

Answer 1

A) Aggregate Demand needs to be increased by 520-280=240 billion

b) If mpc=0.75 then tax multiplier= -Mpc/1-Mpc=-0.75/1-0.75=-3

Tax should be reduced by 80 billion

c)MPC=0.8 then Govt. expenditure multiplier=1/1-Mpc=1/1-0.8=5 and tax multiplier=-Mpc/1-Mpc=-0.8/0.2=4

AD needs to be increased by 240 billion and Taxes needs to be change/decrease by 60 billion