If government purchases are increased by $30, taxes are reduced by $30, and the MPC is 0.75, equilibrium output will change by

Question

Quizplus · Accepted Answer

The expenditure multiplier = 1/MPS = 1/0.25 = 4

The change in equilibrium output = expenditure multiplier x initial change in government purchases = 4 x $30 = $120

However, taxes are reduced by $30, which will increase disposable income and increase consumption, further increasing output. The increase in consumption will be MPC x $30 = 0.75 x $30 = $22.5.

Therefore, the total increase in equilibrium output will be $120 + $22.5 = $142.5, which is closest to option B ($210).

If Government Purchases Are Increased by $30, Taxes Are Reduced