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1
1.Suppose MPC = 0.75, if government increases taxes by $2,000, how much will the household consumption increase or decrease initially?
2. MPC = 0.6. Government wants to increase AD by $500 million, how much should the government spending increase?
Expert Solution
1. MPC= 0.75
MPS= 1-MPC
= 1-0.75
= 0.25
Tax multiplier= -MPC/MPS
= -0.75/0.25
= -3
Change in consumption = Tax multiplier* Increase in Taxes
= (-3)*2000
= -6000
Hence, household consumption decreases by $6000 due to rise in taxes.
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