If the marginal propensity to consume is .80 and both taxes and government purchases increase by $50 billion, GDP will:
A) Increase by $50 billion
B) Decrease by $50 billion
C) Increase by $10 billion
D) Decrease by $10 billion

Question

Quizplus · Accepted Answer

When taxes and government purchases increase by $50 billion, the increase in GDP will depend on the marginal propensity to consume (MPC), which is 0.80 in this case. MPC is the fraction of additional income that is spent on consumption. Therefore, if income rises by $50 billion, consumption will increase by 0.80 x $50 billion = $40 billion. The rest of the income ($10 billion) will be saved or used for other purposes. The increase in consumption will lead to a larger increase in GDP, as consumption is an important component of aggregate demand. Therefore, GDP will increase by more than $50 billion, but the exact amount will depend on the multiplier effect. However, since none of the answer choices reflect this, the most accurate answer is (A) Increase by $50 billion.

If the Marginal Propensity to Consume Is