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.If government transfer payments decrease by 200, which of the following is true?

Question

Quizplus · Accepted Answer

The decrease in transfer payments will reduce disposable income, leading to a decrease in consumption spending. The marginal propensity to save of 0.1 implies that for every $1 decrease in disposable income, saving will decrease by $0.1. Therefore, consumption spending will decrease by $200 - $0.1 * $200 = $180. The decrease in consumption spending will reduce national income by $180 / (1 - mps) = $180 / (1 - 0.1) = $200. The decrease in national income will reduce income tax revenues by $200 * t = $200 * 1/3 = $66.67. The decrease in transfer payments and the decrease in income tax revenues will increase the budget surplus by $200 - $66.67 = $133.33.

Assume an Economy with No Foreign Sector, a Marginal Propensity