Final answer:
With an MPC of 0.8 and a tax cut and government spending decrease both at $100 billion, the aggregate demand will decrease by $100 billion due to the net effect and the multiplier of 5.
Step-by-step explanation:
The marginal propensity to consume (MPC) indicates how much of additional income people will spend rather than save. With an MPC of 0.8, this means for every dollar of income received, 80 cents will be spent and 20 cents saved. When taxes decrease by $100 billion, disposable income increases and consumers will spend according to their MPC, which in this case is an increase in consumption of $80 billion (0.8 x $100 billion). However, if government spending also decreases by $100 billion, this direct spending is removed from the economy. The net effect would be the initial tax cut boost minus the reduced government spending.
Calculating the multiplier effect, where the multiplier equals 1/(1 - MPC), we get a multiplier of 1/(1 - 0.8) = 5. Therefore, the initial $80 billion of increased consumption due to the tax cut would be multiplied within the economy. However, since there is also a $100 billion reduction in government spending, the multiplier would apply to a net change of $-20 billion ($80 billion - $100 billion).
Thus, the overall change in aggregate demand equals the net change multiplied by the multiplier: $-20 billion x 5 = $-100 billion. Therefore, aggregate demand will decrease by $100 billion, making the correct answer (d).