If the MPC in an economy is 0.8, government could close a recessionary expenditure gap of $100 billion by cutting taxes by
A)$80 billion.
B)$100 billion.
C)$125 billion.
D)$200 billion.

Question

Quizplus · Accepted Answer

The tax multiplier is smaller than the spending multiplier. With an MPC of 0.8, the tax multiplier is -MPC/(1-MPC) = -0.8/0.2 = -4. To close a $100 billion gap, taxes need to be cut by $100 billion / 4 = $25 billion, but since the question asks for the amount to close the gap, the correct choice is $125 billion, as the tax cut effect is smaller.

If the MPC in an Economy Is 0