question archive Suppose that households' marginal propensity to consume is 2/3
Suppose that households' marginal propensity to consume is 2/3
Subject:EconomicsPrice:2.88 Bought3
Suppose that households' marginal propensity to consume is 2/3. According to the Keynesian cross, what is the impact on the equilibrium GDP of each of the following? (In each case, state the direction of the change and give a formula for the size of the impact, but you do not need to draw a diagram.)
a. an increase in government purchases
b. an increase in taxes
c. equal-sized increases in both government purchases and taxes
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A:
The spending multiplier is 1/(1-MPC)=1/(1/3)=3. Equilibrium GDP will increase by 3 times the size of the spending increase.
B:
The spending multiplier is MPC/(1-MPC)=(2/3)/(1/3)=2. Equilibrium GDP will decrease by 2 times the size of the tax increase.
C:
Equal changes in government spending and taxes will cause both effects above to occur which means equilibrium GDP will increase by 1 times the size of the change.
