Suppose the marginal propensity to consume is 0.80 and taxes decrease by $10 billion.Which of the following is true?
A) Disposable income and consumption fall by $10 billion
B) Disposable income and consumption rise by $10 billion
C) Disposable income rises by $10 billion and consumption rises by $8 billion
D) Disposable income falls by $10 billion and consumption falls by $8 billion
E) Disposable income rises by $10 billion and consumption falls by $8 billion

Question

Quizplus · Accepted Answer

The marginal propensity to consume (MPC) is the fraction of an additional dollar of disposable income that is spent on consumption. In this case, the MPC is 0.80, which means that for every additional dollar of disposable income, $0.80 will be spent on consumption.

If taxes decrease by $10 billion, disposable income will increase by $10 billion. Using the MPC, we can calculate how much of this increase in disposable income will be spent on consumption:

Change in consumption = MPC x Change in disposable income
Change in consumption = 0.80 x $10 billion
Change in consumption = $8 billion

Therefore, disposable income will rise by $10 billion, and consumption will rise by $8 billion. This is represented by answer choice C, which is the correct answer.

Suppose the Marginal Propensity to Consume Is 0