If the MPC in an economy is .75, a $1 billion increase in taxes will reduce the GDP by:
A)$1 billion.
B)$.75 billion.
C)$3 billion.
D)$4 billion.

Question

Quizplus · Accepted Answer

The MPC (marginal propensity to consume) of .75 means that for every additional dollar of income, people will spend 75 cents and save 25 cents. Therefore, a $1 billion increase in taxes will result in a decrease in disposable income by $1 billion, which will lead to a decrease in consumer spending of $0.75 billion (75% of $1 billion). This decrease in consumer spending will have a multiplier effect on the economy and lead to a total decrease in GDP of $3 billion (multiplier effect = 1/MPC = 1/0.75 = 4; $0.75 billion * 4 = $3 billion).

If the MPC in an Economy Is