If the marginal propensity to consume is.80 and both taxes and government purchases increase by $50 billion, GDP will:
A)increase by $50 billion.
B)decrease by $50 billion.
C)increase by $10 billion.
D)decrease by $10 billion.

Question

Quizplus · Accepted Answer

Since the marginal propensity to consume is 0.80, this means that for every $1 increase in income, people will spend $0.80. Therefore, if taxes and government purchases both increase by $50 billion this will lead to an increase in aggregate demand of $100 billion ($50 billion+$50 billion). The change in GDP will be equal to the change in aggregate demand multiplied by the spending multiplier. If the spending multiplier is 1/ (1-MPC), then the change in GDP will be $125 billion (100/.20). Therefore, GDP will increase by $50 billion.

If the Marginal Propensity to Consume Is