If the marginal propensity to consume is 0.8 and the government reduces taxes by $5 billion, equilibrium income will:
A) fall by $25 billion.
B) rise by $25 billion.
C) rise by $20 billion.
D) fall by $20 billion.

Question

Quizplus · Accepted Answer

The tax multiplier is calculated as -MPC/(1-MPC). With an MPC of 0.8, the tax multiplier is -0.8/(1-0.8) = -4. A $5 billion tax cut increases equilibrium income by 5 * 4 = $20 billion.

If the Marginal Propensity to Consume Is 0