Suppose that the government reduces taxes by $20 billion, that there is no crowding out, and that the marginal propensity to consume is ¾.
a. What is the initial effect of the tax reduction on aggregate demand?
b. What addition effects follow this initial effect? What is the total effect of the tax cut on aggregate demand?
c. How does the total effect of this $20 billion tax cut compare to the total effect of a $20 billion increase in government purchases? Why?
d. Based on your answer to c, how could the government increase aggregate demand without changing the government’s budget deficit?