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Suppose that economists observe that in a closed economy an increase in government spending of $10 billion raises the total demand for goods and services by $30 billion.* If these economists ignore the possibility of crowding out, what would they estimate the marginal propensity to consume (MPC) to be?* Now suppose that the economists allow for crowding out. Would their new estimate of the MPC be larger or smaller than their initial one?Suppose that the government of a closed economy reduces taxes by $20 billion, that there is no crowding out, and that the marginal propensity to consume is 3/4.* What is the initial effect of the tax reduction on aggregate demand?* What additional effects follow this initial effect? What is the total effect of the tax cut on aggregate demand?* How does the total effect of this $20 billion tax cut compare with the total effect of a $20 billion increase in government purchases? Why?
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