Let the marginal leakage rate be 0.5 while the marginal propensity to consume is 0.8.Then a $50 million reduction in autonomous taxes will cause autonomous consumption to ________ and equilibrium income to ________.
A)fall by $50 billion;fall by $100 billion
B)rise by $50 billion;rise by $100 billion
C)fall by $40 billion;fall by $200 billion
D)rise by $40 billion;rise by $80 billion

Question

Quizplus · Accepted Answer

Given: 
Marginal leakage rate (MPS) = 0.5 
Marginal propensity to consume (MPC) = 0.8 
Autonomous tax reduction = $50 million

The formula for calculating the change in equilibrium income due to a change in autonomous taxes is: 
Change in equilibrium income = (autonomous tax change) x (1 - MPS) / (1 - MPC)

Plugging in the values: 
Change in equilibrium income = ($50 million) x (1 - 0.5) / (1 - 0.8) = $40 billion

Therefore, the autonomous consumption will rise by $40 billion and equilibrium income will rise by $80 billion. Hence option D is correct.

Let the Marginal Leakage Rate Be 0