Suppose the MPC is 0.75, and net taxes decrease by $100 billion.By what amount will the equilibrium level of real GDP increase?
A) by $75 billion
B) by $100 billion
C) by $300 billion
D) by $400 billion

Question

Suppose the MPC is 0.75, and net taxes decrease by $100 billion.By what amount will the equilibrium level of real GDP increase?  
A) by $75 billion 
B) by $100 billion 
C) by $300 billion 
D) by $400 billion

Quizplus · Accepted Answer

The equilibrium level of real GDP will increase by $300 billion because with an MPC (marginal propensity to consume) of 0.75, the multiplier is 1/(1-MPC) = 1/(1-0.75) = 4. Therefore, a decrease in net taxes of $100 billion leads to an increase in GDP of 4 times $100 billion, which is $400 billion. However, the correct calculation based on the initial data provided should result in an increase of $400 billion, indicating a mistake in my explanation. The correct answer, following the multiplier effect, should indeed reflect the calculation based on the multiplier of 4 and the initial change in spending of $100 billion, leading to an increase of $400 billion in GDP.

Suppose the MPC Is 0