Suppose inflation is a threat because the current aggregate demand curve will increase by \(\$ 600\) billion at any price level. If the marginal propensity to consume \((M P C)\) is \(0.75,\) federal policymakers could follow Keynesian economics and restrain inflation by a. decreasing taxes by \(\$ 600\) billion. b. decreasing transfer payments by \(\$ 200\) billion. c. increasing taxes by \(\$ 200\) billion. d. increasing government spending by \(\$ 150\) billion.

The Keynesian expenditure multiplier tells us how much total spending will be affected by an initial change in the level of taxation, government spending, or other forms of spending. Given the marginal propensity to consume (MPC) is 0.75, we can calculate this multiplier using the formula: \[ Multiplier = \frac{1}{1-MPC} \] Substituting MPC = 0.75 into the formula gives: \[ Multiplier = \frac{1}{1-0.75} = 4 \] An expenditure of \(1 would ultimately increase total spending by \)4.

Next, we need to calculate the effect on aggregate demand for each action proposed. a. Decreasing taxes by $600 billion: Since a tax cut puts more income into the hands of consumers, and because they will spend 75% of that income, this will increase aggregate demand by \(600 \times 0.75 = 450 \) billion. Due to the multiplier effect, the change in GDP due to the tax cut would be \(4 \times 450 = 1800\) billion, higher than the notable increase in aggregate demand. b. Decreasing transfer payments by $200 billion: This actually reduces income, and therefore reduces spending. This would have the effect of decreasing aggregate demand by \(200 \times 0.75 = 150 \) billion. Due to the multiplier effect, the overall decrease in GDP is \(4 \times 150 = 600 \) billion, which is equal to the excess increase in aggregate demand. c. Increasing taxes by $200 billion: This reduces income and therefore reduces spending, similar to decreasing transfer payments. The impact on aggregate demand would be a decrease by \(200 \times 0.75 = 150 \) billion. With the multiplier, the total decrease in GDP is \(4 \times 150 = 600 \) billion. It's also equal to the excess increase in aggregate demand. d. Increasing government spending by \(150 billion: This directly increases spending, leading to an increase in aggregate demand by \)150 billion. Multiplied by the expenditure multiplier, the total increase would be \(4 \times 150 = 600 \) billion, which does not help in this case since it is equal to the unwanted increase.

The problem requests that we find a solution to counteract the increase in aggregate demand. Therefore, we need an option that reduces aggregate demand by \(600 billion. From the calculations in Step 2, we can see that both option b (decreasing transfer payments by \)200 billion) and c (increasing taxes by $200 billion) both meet the criteria. So, both option b and c are the correct answers.