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Homework answers / question archive / If the Marginal Propensity to Consume (MPC) is
If the Marginal Propensity to Consume (MPC) is .90, estimate the total (multiplied) effect of government purchases/spending of $100B in the economy in terms of its aggregate expenditure (Hint: Multiplier = 1 / 1 – MPC).
Calculate the net cumulative change in the aggregate expenditure if taxes were cut by $200 billion and MPC is estimated to be .75.
What if government expenditure was increased by $200 billion?
i) MPC = 0.9
Change in government spending = $100 billion
Multiplier = (1 / 1 – MPC) = 1/(1-0.9) = 1/0.1 = 10
Change in Income = Multiplier x Change in government spending = 10 x 100 = $1000 Billion
Total Effect = $1000 Billion
ii) MPC = 0.75
Change in government spending = $100 billion
Change in taxes = -$200 billion
Tax mulitiplier = -MPC/(1-MPC) = -0.75/0.25 = -3
Change in Income due to taxes = -3 x -200 = $600 Billion
Government multiplier = 1/(1-mpc) = 1/0.25 = 4
Change in income due to spending = 4 x 100 = $400 Billion
Total effect = 400 + 600 = $1000 billion
iii)
Change in government spending = $100 billion
Change in taxes = -$200 billion
Tax mulitiplier = -MPC/(1-MPC) = -0.75/0.25 = -3
Change in Income due to taxes = -3 x -200 = $600 Billion
Government multiplier = 1/(1-mpc) = 1/0.25 = 4
Change in income due to spending = 4 x 200 = $800 Billion
Total effect = 800 + 600 = $1400 billion