An economy that is currently in equilibrium and at full employment has an increase in Disposable income of $50 billion. If the marginal propensity to consume is 80%, what will be the increase in real GDP? If this income is taxed, will that change the impact on real GDP?

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An economy that is currently in equilibrium and at full employment has an increase in Disposable income of $50 billion

Economics Nov 04, 2020

An economy that is currently in equilibrium and at full employment has an increase in Disposable income of $50 billion.

If the marginal propensity to consume is 80%, what will be the increase in real GDP?
If this income is taxed, will that change the impact on real GDP?

Expert Solution

Ans-a Given that MPC=80% or 0.80

Income multiplier=1/1-MPC

Income multiplier=1/1-0.80

Income multiplier=1/0.20

Income multiplier=5

Increase in income(?Y)=$50 billion

Increase in real GDP=50×5=$250 billion.

B) When income is taxed it decreaes the economic activity through short run demand-side effects i.e reducing actual GDP below potential GDP as lower disposable income causes decline in Consumption or investment.

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