Question

In: Economics

5. Explain the effects of the following actions on equilibriumincome, assuming that the marginal propensity...

5. Explain the effects of the following actions on equilibrium income, assuming that the marginal propensity to consume is 0.8

A. Government purchases rise by $40 billion.

B. Taxes fall by $40 billion.

Expert Solution

Solution:

a)

Spending multiplier =1/(1-MPC)

=1/(1-0.8)

=5

Change in equilibrium income eventually =intial change in government spending * spending multiplier

=40*5

=$200 billion

the equilibrium income increases by $200 billion.

--------

b)

tax multiplier =-MPC/(1-MPC)

=-0.8/(1-0.8)

=-4

Change in equilibrium income eventually =intial change in tax * multiplier

=(-40)*(-4) .......... the negative sign shows a decrease

=$160 billion

THe equilibrium income increases by $160 billion

Rahul Sunny answered 2 years ago

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