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# Government purchases

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Suppose that economists observe that in a closed economy an increase in government spending of \$10 billion raises the total demand for goods and services by \$30 billion.

* If these economists ignore the possibility of crowding out, what would they estimate the marginal propensity to consume (MPC) to be?
* Now suppose that the economists allow for crowding out. Would their new estimate of the MPC be larger or smaller than their initial one?

Suppose that the government of a closed economy reduces taxes by \$20 billion, that there is no crowding out, and that the marginal propensity to consume is 3/4.
* What is the initial effect of the tax reduction on aggregate demand?
* What additional effects follow this initial effect? What is the total effect of the tax cut on aggregate demand?
* How does the total effect of this \$20 billion tax cut compare with the total effect of a \$20 billion increase in government purchases? Why?

https://brainmass.com/economics/demand-supply/government-purchases-97296

#### Solution Preview

Hello!

1) Suppose that economists observe that in a closed economy an increase in government spending of \$10 billion raises the total demand for goods and services by \$30 billion.

* If these economists ignore the possibility of crowding out, what would they estimate the marginal propensity to consume (MPC) to be?

If there's no crowding out, then the multiplier equals 1/(1-MPC). Since the multiplier is 3, then MPC = 2/3.

* Now suppose that the economists allow for crowding out. Would their new estimate of the MPC be larger or smaller than their initial one?

If there's ...

#### Solution Summary

Effects on aggregate demand are implied.

\$2.19