Suppose the marginal propensity to consume is 0.8. If the government cut taxes by $100 billion, then real GDP would increase by $400 billion.

Question

Quizplus · Accepted Answer

If the marginal propensity to consume is 0.8, then the multiplier is 1/1-MPC = 1/0.2 = 5. This means that a $100 billion tax cut would lead to a $500 billion increase in real GDP (5 times the tax cut). Therefore, the statement that real GDP would increase by $400 billion is false, and the correct answer is A.

Suppose the Marginal Propensity to Consume Is 0