If the savings function is S = - 400 + (0.25)YD, the marginal income tax rate is t = 0.2, and the equilibrium level of income increases by 1,000, by how much will consumption change?

Question

Quizplus · Accepted Answer

First, we need to find the new equilibrium level of income:
Y' = Y + 1,000
Then, we can find the new level of disposable income:
YD' = Y' - T(Y')
YD' = Y + 1,000 - 0.2(Y + 1,000)
YD' = 0.8Y + 800
Now we can plug this new YD' into the savings function to find the new savings level:
S' = -400 + (0.25)(0.8Y + 800)
S' = -200 + 0.2Y
The change in consumption will be the difference between the new and old levels of disposable income:
ΔC = YD' - YD
ΔC = (0.8Y + 800) - (0.8Y - 200)
ΔC = 1,000
Therefore, consumption will increase by 600 (Choice C).

If the Savings Function Is S = - 400