Suppose President Obama is successful in passing a $10 billion tax increase.Assume that taxes are fixed,the economy is closed,and the marginal propensity to consume is 0.8.What happens to equilibrium GDP?

Question

Quizplus · Accepted Answer

Since the marginal propensity to consume is 0.8, a tax increase of $10 billion would result in a decrease in consumption spending of $8 billion (0.8 x $10 billion). This decrease in consumption spending would lead to a decrease in equilibrium GDP of 4 times the initial change in spending, or $32 billion (4 x $8 billion). Therefore, the total change in equilibrium GDP would be a decrease of $40 billion ($32 billion decrease in consumption spending plus $10 billion tax increase).

Suppose President Obama Is Successful in Passing a $10 Billion