Assume an economy with no foreign sector, a marginal propensity to save of mps = 0.1, and a marginal income tax rate of t = 1/3.What change in government purchases would lead to an increase in national income of 500?

Question

Quizplus · Accepted Answer

The spending multiplier formula is given as:
1/(1-mpc*(1-t))
Here, mpc = 1-mps = 0.9 (marginal propensity to consume)
Substituting the given values, we get:
1/(1-0.9*(1-1/3)) = 3.03
This means that a change in government purchases by $1 would lead to a change in national income by $3.03.
To achieve an increase of $500 in national income, we need a change in government purchases of:
500/3.03 = 165
Since the change in government purchases has to be in multiples of 50 (based on the answer choices), the closest option is $200 (C), which would lead to an increase in national income of:
3.03 * 200 = $606.

Assume an Economy with No Foreign Sector, a Marginal Propensity