ECONOMICS (CBSE/UGC NET)

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ECONOMICS

AGGREGATE DEMAND

Question [CLICK ON ANY CHOICE TO KNOW THE RIGHT ANSWER]
Hamsterville, where the marginal propensity to save is equal to 0.25, is currently experiencing a negative output gap of $60 million.How much would Hamsterville’s government have to change taxes to restore the full employment level of aggregate output?
A
Taxes should be increased by $60 million
B
Taxes should be reduced by $10 million
C
Taxes should be reduced by $20 million
D
Taxes should be increased by $15 million
E
Taxes should be reduced by $5 million
Explanation: 

Detailed explanation-1: -If the marginal propensity to save is 0.25 in an economy with no taxes and no imports, the marginal propensity to consume is 1.25. Changes in unplanned inventory investment move the economy toward the income-expenditure equilibrium. positive and negative multiplier effects.

Detailed explanation-2: -Since the consumption function will be C = 0.8 (GDP-T), the multiplier will be 1 / (1-MPC) or 1 / MPS = 1 / 0.2 = 5.

Detailed explanation-3: -Aggregate Expenditure = C + I + G + (X – M). Finally, note that this example includes income taxes; thus, people consume out of disposable income (or take-home pay).

Detailed explanation-4: -If the government decreased its spending by $400, and the GDP decreased $1, 000 as a result, the MPC must be: A. 0.60.

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