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If the Marginal Propensity to Consume (MPC) is

Economics

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?

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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