In the Keynesian-cross model, if the MPC equals 0.75, then a $1 billion decrease in taxes increases planned expenditures by ______ and increases the equilibrium level of income by ______.
A) $1 billion; more than $1 billion
B) $0.75 billion; more than $0.75 billion
C) $0.75 billion; $0.75 billion
D) $1 billion; $1 billion

Question

Quizplus · Accepted Answer

A decrease in taxes would increase disposable income, and with an MPC of 0.75, 75% of that increase would be spent, leading to an increase in planned expenditures of $0.75 billion. This increase in planned expenditures would shift the aggregate expenditures line upward, causing an increase in equilibrium income. The size of the increase in equilibrium income would be the multiplier effect of the initial change in planned expenditures, which is greater than 1 in the Keynesian-cross model. Therefore, the increase in equilibrium income would be more than $0.75 billion.

In the Keynesian-Cross Model, If the MPC Equals 0