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Taxes and aggregate demand

1. In a certain year the aggregate amount demanded at the existing price level consists of $100 billion of consumption, $40 billion of investment, $10 billion of net exports, and $20 billion of government purchases. Full-employment GDP is $120 billion. To obtain price level stability under these conditions the government should:

increase tax rates and reduce government spending.

discourage personal saving by reducing the interest rate on government bonds.

increase government expenditures.

encourage private investment by reducing corporate income taxes.

2. We can expect the IS-curve to get steeper, as:

money demand becomes less sensitive to changes in the interest rate
the marginal propensity to save increases
investment becomes more sensitive to changes in the interest rate
the income tax rate decreases
the expenditure multiplier increases

3. If the government increases taxes, which of the following is LEAST likely to occur?
a decrease in private domestic saving
a decrease in consumption
an increase in private domestic investment
a decrease in net exports
a decrease in national income

Solution Preview

. In a certain year the aggregate amount demanded at the existing price level consists of $100 billion of consumption, $40 billion of investment, $10 billion of net exports, and $20 billion of government purchases. Full-employment GDP is $120 billion. To obtain price level stability under these conditions the government should:

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Solution Summary

Price stability and the economic effects of taxation

$2.19