MindTap Fiscal Policy (Aplia) Due on Jul 17 at 11:59 PM EDT 3. The multiplier ef
ID: 1225039 • Letter: M
Question
MindTap Fiscal Policy (Aplia) Due on Jul 17 at 11:59 PM EDT 3. The multiplier effect Aa Aa Consider a hypothetical closed economy in which households spend $0.75 of each additional dollar they earn and save the remaining $0.25. The marginal propensity to consume (MPC) for this economy is multiplier for this economy is and the Suppose the government in this economy decides to decrease government purchases by $250 billion. The decrease in government purchases will lead to a decrease in income, generating a decrease in consumption that decreases income yet again, and so on. Fill in the following table to show the impact of the change in government purchases on the first two rounds of consumption spending and, eventually, on aggregate demand -$250 billion Change in Government Purchases First Change in Consumption Second Change in Consumption Total Change in Demand To bring about a decrease in consumption equal to the decrease in government purchases (that is, $250 billion), the government would have to increase taxes by decrease in total demand as the decrease in government purchases, the multiplier for a tax increase (known as the tax multiplier) must be taxes leads to a decrease in total demand.) billion. Since this increase in taxes would lead to the same (Note: The tax multiplier is expressed as a negative number, since an increase in Which of the following formulas for the tax multiplier is correct and consistent with this quantitative result? Tax multiplier = (1-MPC)/-MPC
Explanation / Answer
Marginal propensity to consume is that proportion of an increase in pay which a consumer spends. Here for every dollar earned, onsumer spends 0.75. Thus MPC is 0.75.
We know that K = 1/(1-MPC) where k is multiplier, multiplier = 1/(1-0.75) = 1/0.25 = 4
First Change in consumption = 1/0.25 * - 250 = -1000 consumption reduces by 1000.
second change = 4* -1000 = -4000. consumption decreases by 4000.
change in demand = -5000.