For a marginal propensity to consume of 0.9, the multiplier effect of an increase of $100 billion in government purchases of goods and services is smaller than the multiplier effect of a tax cut of $100 billion.

Question

Quizplus · Accepted Answer

The multiplier effect of government purchases of goods and services is given by the formula:
Multiplier effect = 1 / (1 - MPC)
where MPC is the marginal propensity to consume.
In this case, with an MPC of 0.9, the multiplier effect is:
Multiplier effect = 1 / (1 - 0.9) = 10
So an increase of $100 billion in government purchases of goods and services would have a multiplier effect of $100 billion x 10 = $1 trillion.
The multiplier effect of a tax cut, on the other hand, is given by the formula:
Multiplier effect = MPC / (1 - MPC)
In this case, with an MPC of 0.9, the multiplier effect would be:
Multiplier effect = 0.9 / (1 - 0.9) = 9
So a tax cut of $100 billion would have a multiplier effect of $100 billion x 9 = $900 billion.
Therefore, the statement is false. The multiplier effect of an increase in government purchases is actually larger than the multiplier effect of a tax cut.

For a Marginal Propensity to Consume of 0