Households within a hypothetical economy have a propensity to spend seventy-five
ID: 1105982 • Letter: H
Question
Households within a hypothetical economy have a propensity to spend seventy-five cents of each additional dollar of disposable income. Autonomous consumption expenditures are equal to one thousand. Taxes are autonomous and equal to 400. Transfer payments and government expenditures are autonomous and equal to three hundred, and eleven hundred respectively. Investment, exports, and imports are autonomous; total autonomous expenditures, E0, are equal to six thousand. If the government were to increases taxes by 200, by how much, if at all, will the equilibrium level of output change? Include in your equation the numbers above to show your work.
Explanation / Answer
Marginal propensity to spend (MPC) = $0.75 / $1 = 0.75
Tax multiplier = - MPC / (1 - MPC) = - 0.75 / (1 - 0.75) = - 0.75 / 0.25 = - 3
This signifies that as Tax increases by 1 unit, output decreases by 3 units. Therefore,
As Tax increases by 200 units, output decreases by (200 x 3) = 600 units.
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