Real GDP equals $400 billion, the government collects 25% of any increase in real GDP in the form of taxes, and the marginal propensity to consume is 0.8. If the government decreases spending by $40 billion, real GDP will decrease by:

Question

Quizplus · Accepted Answer

The government collects 25% of any increase in real GDP, but the question does not mention any changes in real GDP due to the decrease in government spending. Hence, we can assume that real GDP remains at $400 billion. 
The marginal propensity to consume is 0.8, which means that for every $1 decrease in disposable income, consumption decreases by $0.8. The decrease in government spending by $40 billion will directly decrease aggregate demand by $40 billion. Given the marginal propensity to consume of 0.8, the total decrease in real GDP would be:
$40 billion x (1/1-0.8) = $200 billion
Therefore, the answer is C.

Real GDP Equals $400 Billion, the Government Collects 25% of Any