If the marginal propensity to consume is 0.75 and taxes increase by $30 billion, real GDP will:
A)increase by exactly $30 billion.
B)decrease by exactly $30 billion.
C)decrease by less than $120 billion.
D)decrease by more than $120 billion.

Question

Quizplus · Accepted Answer

The marginal propensity to consume is the increase in consumer spending resulting from a given increase in disposable income. In this case, if taxes increase by $30 billion, disposable income will decrease by $30 billion, and if the marginal propensity to consume is 0.75, consumption will decrease by 0.75 times $30 billion, or $22.5 billion. Therefore, real GDP will decrease by less than $120 billion (which would be the case if the full $30 billion decrease in disposable income was saved and not spent), but the exact amount of decrease will depend on the overall size of the economy and other factors affecting consumer behavior.

If the Marginal Propensity to Consume Is 0