Assume that there is no accelerator affect.The MPC = 3/4.The government increases both expenditures and taxes by $600.The effect of taxes on aggregate demand is 3/4 the size of that created by government expenditures alone.The crowding out effect is 1/5 as strong as the combined effect of government expenditures and taxes on aggregate demand.How much does aggregate demand shift by?
A)$1480
B)$480
C)$160
D)None of the above is correct.

Question

Quizplus · Accepted Answer

The initial government expenditure (G) increase of $600 will directly increase aggregate demand by $600. The tax increase of $600 will decrease aggregate demand by (3/4) x $600 = $450 (since the MPC is 3/4).

Therefore, the net effect on aggregate demand is $600 - $450 = $150.

The crowding out effect, which decreases the initial impact on aggregate demand, is (1/5) of the initial impact, or (1/5) x $600 = $120.

Therefore, the final shift in aggregate demand is $150 - $120 = $30.

Thus, aggregate demand shifts by $30, which corresponds to answer choice B.

Assume That There Is No Accelerator Affect