If MPC= 0.6. If the government increases expenditures by $200 billion, what is the impact of AD or SRAS, on P and Y? If the government decreases taxes by $200 billion what is the effect on AD or AS on P and Y?

To determine the impact of changes in government expenditures and taxes on aggregate demand (AD) or aggregate supply (AS), as well as their effects on the price level (P) and real GDP (Y), we need to consider the concept of the multiplier and the relationship between AD/AS, P, and Y.

Multiplier:
The multiplier represents the proportional impact of an initial change in spending or income on the overall economy. It is calculated as 1 divided by the marginal propensity to consume (MPC) or save (MPS). The MPC is the proportion of additional income that households spend rather than save.

In this case, the given MPC is 0.6, which means that for every additional dollar of income, households will spend 60 cents and save 40 cents.

Effect of increase in government expenditures:
If the government increases expenditures by $200 billion, this will directly increase aggregate demand. The initial impact on AD can be calculated by multiplying the change in government expenditures by the multiplier.

Multiplier = 1 / MPC = 1 / 0.6 = 1.67 (rounded)

Initial impact on AD = Change in government expenditures * Multiplier
= $200 billion * 1.67
= $334 billion

The increase in AD will lead to an increase in both the price level (P) and real GDP (Y) due to higher spending and demand in the economy. However, the exact magnitude of the impact on P and Y will depend on the curves of aggregate supply and aggregate demand and their intersection.

Effect of decrease in taxes:
If the government decreases taxes by $200 billion, this will increase households' disposable income, which will, in turn, increase consumption spending. The change in AD due to the tax cut can also be determined using the multiplier.

Initial impact on AD = Change in taxes * MPC * Multiplier
= -$200 billion * 0.6 * 1.67
= -$200 billion * 1.002
≈ -$200 billion (since the result is very close to -$200 billion)

The decrease in taxes will cause a decrease in AD, potentially leading to a decrease in both the price level (P) and real GDP (Y), depending on the shapes of the AD and AS curves and their intersection point.

Remember that these calculations give you the initial impact, and the ultimate effect on P and Y may be influenced by various other factors and the dynamics of the economy.

Take a shot, what do you think?

Hint. The government spending multiplier in this example is 1/MPS = 1/.4 = 2.5. The taxation multiplier is the government multiplier minus one = 1.5