Suppose the government wanted to initially increase consumer spending by $540,00

Question

Suppose the government wanted to initially increase consumer spending by $540,000. By how much would the government have to lower taxes if the marginal propensity to consume is 0.9? Suppose the government wanted to initially increase consumer spending by $540,000. By how much would the government have to lower taxes if the marginal propensity to consume is 0.9? Suppose the government wanted to initially increase consumer spending by $540,000. By how much would the government have to lower taxes if the marginal propensity to consume is 0.9?

Explanation / Answer

Marginal propensity to consume (MPC): This is the ratio of change in consumer spending (C) to change in consumer income (Y). Here consumer income could only be increased if the government reduces tax.

MPC = C / Y

0.9 = $540,000 / Y

Y = $600,000

Answer: The government has to lower taxes by $600,000 to increase the income effect of consumers for increasing their spending.

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