suppose the government reduces taxes by 20billion that there

suppose the government reduces taxes by $20billion, that there is no crowding out and the marginal propensity to consume is 3/4

a. what is the initial effect of the tax reduction on aggregat demand?

b. what additional effect follow this initial effect? what is the total effect of the tax cut on aggregate demand?

c. how does the total effect of this $20 billion tax cut compare to the total effect of a $20 billion increase in government purchase? why?

d. based on your answer to part (c), can you think of a way in which the government can increase aggregate demand without changing the government\'s budget deficit?

Solution

a) Aggregate Demand will increase as a result of reducing taxes by the government. People will be willing to incur more on the purchase of goods and services during such time period.

b) As a result of increase in aggregate demand, Level of income in the economy expand.

d) The government can increase aggregate demand without changing the government\'s budget deficit by promoting exports i.e. expenditure made by foreigners on our goods which will be added to total expenditure and consequently aggregated demand will also increase.