In the short-run Keynesian model where the marginal propensity to consume is 0.75, to offset an expansionary gap resulting from a $1 billion increase in autonomous consumption, taxes must be:
A)increased by $1 billion.
B)decreased by $1 billion.
C)increased by $1.33 billion.
D)decreased by $1.33 billion.

Question

Quizplus · Accepted Answer

To offset an expansionary gap of $1 billion, autonomous expenditures must decrease by $1 billion. An mpc of 0.75 means that households will reduce autonomous spending by only 75 percent of any increase in taxes (they will pay for the other 25 percent by saving less), so the increase in taxes that is needed is $1 billion/ 0.75 = $1.33 billion.

In the Short-Run Keynesian Model Where the Marginal Propensity to Consume