If taxes were cut by $1 trillion and the MPC was 0.75, by how much would total s

Question

If taxes were cut by $1 trillion and the MPC was 0.75, by how much would total spending a. Increase in the first year with two spending cycles? trillion b. Increase over three years, with two spending cycles per year? trillion c. Increase over an infinite time period? trillion If taxes were cut by $1 trillion and the MPC was 0.75, by how much would total spending a. Increase in the first year with two spending cycles? trillion b. Increase over three years, with two spending cycles per year? trillion c. Increase over an infinite time period? trillion

Explanation / Answer

a) In the first period, when taxes are cut worth $1 trillion, disposable income increases by $1 trillion so consumption increases by $0.75 trillion. In second cycle, when income is increased by $0.75 trillion, consumption is increased by 0.75*0.75 = 0.5625 trillion. Hence in first year, the increase in total spending is 1.3125 trillion

b) This value is 2.466 trillion as shown below

c) Total increase = -MPC/1-MPC * -1 trillion = -0.75/0.25 * -1 = 3 trillion.  

Year Period Increase in income 1 0.75 1st 2 0.5625 1.3125 3 0.421875 2nd 4 0.316406 5 0.237305 third 6 0.177979 2.466064

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