Consider a small country that is closed to trade, so its net exports are equal to zero. The following equations describe the economy of this country in billions of dollars, where C is consumption, DI is disposable income, I is an investment, and G is government purchases:
C = 100 + 0.75 times DI
G = 50
I = 80
Initially, this economy had a lump-sum tax. Suppose net taxes were $40 billion so that disposable income was equal to Y - 40, where Y is real GDP. In this case, this economy's aggregate output demanded was __________.
Suppose the government decides to increase spending by $10 billion without raising taxes. Because the spending multiplier is __________, this will increase the economy's aggregate output demanded by __________.
Now suppose that the government switches to a proportional tax on the income of 5%. Because consumers retain the remaining 95% of their income, disposable income is now equal to 0.95Y. In this case, the economy's aggregate output demanded is __________.
Under a proportional tax on the income of 5%, the spending multiplier is approximately __________. Therefore, if the government decided to increase spending by $10 billion without raising tax rates, this would increase the economy's aggregate output demanded by approximately __________.
A $10 billion increase in government purchases will have a larger effect on output under a __________.