suppose that the marginal propensity to consume is 0

Economics Nov 07, 2020

suppose that the marginal propensity to consume is 0.8 and there are no proportional taxes. if government wants to decrease equilibrium output by 500, then by how much must it change the autonomous demand?

Expert Solution

To answer this question we have to find the size of the multiplier (K). We have MPC=0.8. Using the following formula, we can find the size of the multiplier K:

$K=\frac{1}{1-MPC}$

$K=\frac{1}{1-0.8}=\frac{1}{0.2}=5$

Thus, the value of K=5. That means, any change in the government expenditure will change the autonomous demand (aggregate demand=Y) 5 times. Using the following formula:

$K=\frac{\Delta Y}{\Delta G}$

$5=\frac{-500}{\Delta G}$

$\Delta G=\frac{-500}{5}=-100$

Thus, given MPC=0.8, to reduce the aggregate demand by 500, the government has to reduce the government expenditure by 100.

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