Assume autonomous net taxes rise by $500, and the marginal propensity to consume equals 0.75.Net exports, planned investment, taxes, and government purchases are autonomous and remain fixed.As a result, how will equilibrium real GDP demanded change?
A) It will rise by $500.
B) It will fall by $500.
C) It will rise by $1,500.
D) It will fall by $1,500.

Question

Assume autonomous net taxes rise by $500, and the marginal propensity to consume equals 0.75.Net exports, planned investment, taxes, and government purchases are autonomous and remain fixed.As a result, how will equilibrium real GDP demanded change?  
A) It will rise by $500. 
B) It will fall by $500. 
C) It will rise by $1,500. 
D) It will fall by $1,500.

Quizplus · Accepted Answer

When autonomous net taxes increase, disposable income decreases, leading to a reduction in consumption. Given the marginal propensity to consume (MPC) is 0.75, the multiplier is 1/(1-MPC) = 4. Therefore, a $500 increase in taxes reduces equilibrium real GDP demanded by 4 times $500, which is $2000, not $1500 as initially calculated. The correct interpretation of the multiplier effect would indeed suggest a significant impact, but the precise numerical answer provided in the options does not align with the correct calculation. Thus, while the direction indicated in D is correct (a fall in GDP), the exact amount specified ($1,500) is based on an oversight in the calculation presented. The correct calculation should lead to a $2000 decrease, but given the options provided, D is the closest to the correct direction of change.

Assume Autonomous Net Taxes Rise by $500, and the Marginal