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Assume that a hypothetical economy with an MPC of 0.8 is experiencing severe recession. a. By how much would government spending have to rise to shift the aggregate demand curve rightward by $25 billion? How large a tax cut would be needed to achieve the same increase in aggregate demand? Instructions: Round your answer to 2 decimal places and enter your answer as a positive number. b. Determine one possible combination of government spending increases and tax increases that would accomplish the same goal without changing the amount of outstanding debt.

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Answer and Explanation:

a. The amount that the government spending have to rise to shift the aggregate demand curve rightward by $25 billion is $5 million

Thus:

The multiplier is 1/1-0.8 = 1/0.2 = 5 million

Tax cut would be necessary to achieve the same increase in aggregate demand is $6.25 billion which is = (5 /0.8).

The part of tax saving is going to be:

($6.25 -$5 =$1.25 billion)

b. One possible combination is $1 billion on government spending, and tax cut will decrease in $5 billion in order to accomplish the same goal.

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