Suppose the government reduces taxes by $20 billion, that there is no crowding out, and that the marginal propensity to consume is ¾.
a. What is the initial effect of the tax reduction on aggregate demand?
b. What additional effects 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 purchases? 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?
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