Assume in a private economy that the equilibrium level of income is $380 and the MPS is 0.25.Now suppose government collects taxes of $50 and spends the entire amount.As a result:
A)the equilibrium level of real income and the price level will both remain unchanged.
B)nominal wage rates will fall.
C)the equilibrium level of income will rise to $420.
D)the equilibrium level of income will rise to $430.

Question

Quizplus · Accepted Answer

The government spending of $50 will increase the aggregate demand in the economy. The multiplier effect will cause the equilibrium level of income to rise. The formula for the multiplier effect is: 
Multiplier = 1/(1-MPC) 
where MPC is the marginal propensity to consume, and in this case, it is (1-MPS) = 0.75.
So, Multiplier = 1/(1-0.75) = 4.

Therefore, the increase in government spending of $50 will lead to an increase in equilibrium income of:
ΔY = 4 x ΔG = 4 x $50 = $200

Thus, the new equilibrium level of income will be:
Y = $380 + $200 = $580

Therefore, the correct answer is D, the equilibrium level of income will rise to $430.

Assume in a Private Economy That the Equilibrium Level of Income