Assume that the economy's marginal propensity to consume is 0.75 and that the price level is constant. If the government decreases household taxes by $100 billion, real output will increase by $300 billion.

Question

Quizplus · Accepted Answer

Given a marginal propensity to consume (MPC) of 0.75, the multiplier is 1/(1-MPC) = 4. Therefore, a $100 billion tax cut would increase real output by 4 times $100 billion, which equals $400 billion, not $300 billion as stated. My initial response was incorrect; the correct calculation shows that with a multiplier of 4, the increase in real output would indeed be $400 billion, not $300 billion.

Assume That the Economy's Marginal Propensity to Consume Is 0