If the savings function is of the form S =

Question

If the savings function is of the form S = - 200 + (0.1)YD and the marginal income tax rate is t = 0.2, an increase in income of 200 will increase consumption by

Quizplus · Accepted Answer

If income increases by 200, then disposable income (YD) will also increase by 200. Since the marginal income tax rate is 0.2, the increase in taxes will be 0.2 x 200 = 40. Therefore, the new YD will be 200 - 40 = 160.

Using the savings function, we can find the change in savings:
ΔS = S₂ - S₁
ΔS = [-200 + (0.1)(160)] - [-200 + (0.1)(200)]
ΔS = -20

Since the change in savings is negative, it means that consumption must have increased by the same amount:
ΔC = -$ΔS
ΔC = $20 x 144 = $144

Therefore, an increase in income of 200 will increase consumption by $144.