Question

suppose the president is successful in passing a $10 billion tax increase. assume that taxes are fixed, the economy is closed, and the marginal propensity to consume is 0.8. what happens to equilibrium gdp?

Answer 1

The equilibrium GDP will decrease by $2 billion due to the $10 billion tax increase.

Step-by-step explanation:

To find the equilibrium GDP, we need to determine the change in aggregate demand caused by the tax increase. The tax increase of $10 billion reduces disposable income for households, which in turn reduces consumption.

The marginal propensity to consume (MPC) is 0.8, so for every dollar decrease in disposable income, consumption decreases by 80 cents. As a result, the change in aggregate demand caused by the tax increase is $10 billion * (1 - 0.8) = $2 billion.

Equilibrium GDP is determined by the intersection of aggregate demand (AD) and aggregate supply (AS). The decrease in aggregate demand caused by the tax increase shifts the AD curve to the left.

This will result in a decrease in the equilibrium GDP by an amount equal to the decrease in aggregate demand.

Therefore, the equilibrium GDP will decrease by $2 billion due to the tax increase.