Problem: A government is currently operating with an annual budget deficit of $40 billion. The government has determined that:
- The marginal propensity to consume is 0.75.
- To eliminate an inflationary gap and take into account the resulting change in the price level, the government must generate a net leftward shift in the aggregate demand curve equal to $40 billion.
Assuming that there are no direct expenditure offsets to fiscal policy, how much should the government increase taxes? Explain by giving appropriate reasons.