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Evaluating Policy Tools for Stimulating Aggregate Demand
An economy's total demand (AD) is determined by the equation: AD = (c₀ + c₁(1−t)Y) + (a₀ − a₁r) + G + (X − mY), where c₀ is autonomous consumption, c₁ is the marginal propensity to consume, t is the income tax rate, Y is income, a₀ is autonomous investment, a₁ is the interest rate sensitivity of investment, r is the interest rate, G is government spending, X is exports, and m is the marginal propensity to import.
A government is considering two policies to increase aggregate demand, with each policy having the same cost to the government's budget: (1) directly increasing government spending (G), or (2) cutting the income tax rate (t).
Evaluate which of these two policies would have a larger initial impact on aggregate demand. Justify your reasoning by explaining how each policy affects the components of the aggregate demand equation.
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Ch.5 Macroeconomic policy: Inflation and unemployment - The Economy 2.0 Macroeconomics @ CORE Econ
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