Question

Assume the tax multiplier is estimated to be 1.3 and the aggregate supply curve has its usual upward slope. Suppose the government lowers taxes by ​$135 million. Aggregate demand will increase by ​$____ nothing million. ​(Enter your response rounded to one decimal​ place.)

Answer 1

Increase in aggregate demand : $175.5 million

Step-by-step explanation:

Taxation is a factor that affects the demand curve. When taxes rise, it means that a higher proportion of income would be used to pay taxes, leading to a lower disposable income. On the other hand, when taxes fall, there would be an increase in disposable incomes. Hence, consumers will have more to spend on their needs and wants, increasing their consumption.

Aggregate demand consists of Consumption (C), Investment (I), Government spending (G) and Net exports (X - M).

As is shown, consumption is one of the components of aggregate demand, thus when consumption increases, aggregate demand increases.

In order to calculate by how much this increase is, we need to understand the tax multiplier. This is measure of the change in GDP in response to a change in government taxes. In this case, the tax multiplier is 1.3 whilst decrease in government tax is $135 million. This means that for every $1 fall in taxes, aggregate demand rises by $1.3

Hence, increase in aggregate demand = 1.3 x $135 million

$175.5 million