Suppose in a closed economy, the government lowers taxes by 100 billion. If the marginal propensity...

Suppose in a closed economy, the government lowers taxes by 100 billion. If the marginal propensity to consume is 0.8 and the government purchases remain unchanged, what happens to the following? That is, do they rise or fall? By how much?

a. Public saving.

b. Disposable income.

c. Household consumption.

d. Private saving.

e. National saving.

f. Investment.

Solutions

Expert Solution

(a) Public saving is government saving which is equal to Government Revenue or taxes - Government Expenditure. With reduction in taxes and unchaged government expenditure, public saving will fall by 100 Million.

(b) Disposable Income = Income - Taxes (or YD = Y - T)

Therefore, disposable income will increase by the 100 miilion with the reduction in tax outlay.

(c) Hosuehold consumption increase = MPC X Increase in disposable Income = 0.80 X 100 Million = 80 Million

(d) Private saving increase = Marginal Propensity to save X Increase in disposable Income = (1-MPC) X 100 Million = 0.20 X 100 Million = 20 Million

(e) National saving = Private Saving + Public Saving

=>Incremental National saving = Incremental Private Saving + Incremental Public Saving = 20 - 100 = (-) 80 Million.

Therefore, National saving falls by 80 Million

f) Investments = National Savings

Therefore Investments also fall by 80 Million.

Rahul Sunny answered 2 years ago

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