3. There is a tax-cut that increases your Disposable Income by $3,400, wbich you

Question

3. There is a tax-cut that increases your Disposable Income by $3,400, wbich you intend to save $510. Calculate the MPC. MPC is 0.85 Interpret this MPC. (What does it mean? Define MPC and describe in this context.) "This means that you will spend (consume) 85% of the increase in your disposable income and will save 15%. MPC is the marginal propensity to consume which is the amount of your income that you plan on spending. What is the resulting fiscal multiplier? "1/( l-MPC): 1/( 1-0.85)=1/0.15 a. b. c. d. Interpret the multiplier and describe the multiplier effect e. Find the total change to the economy from this tax change

Explanation / Answer

3.

A

MPC = Change in consumption / change in income = (3400-510)/3400

MPC = .85

B.

MPC shows that how much percentage of income will be spent or consumed again. In this case, if income increases, then 85% of the income will be consumed again. So, MPC in the given case is .85.

C.

Fiscal multiplier = 1/(1-MPC) = 1/(1-.85) = 1/.15 = 6.67

D.

The fiscal multiplier shows the multiplier impact of the increase or decrease of fiscal spending. In the given case the fiscal multiplier is 6.67. It means that $1 spent by the government will increase the output level by $6.67 and vice versa.

E.

Tax multiplier = -MPC/(1-MPC) = -.85/.15 = -5.67

So, increase in output (due to reduction taxes by $3400) = 3400*5.67 = $19278

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