The government raises taxed by €100 billion. If the marginal propensity to consume is 0.6, what happens to public savings? What will happen to private savings? What will happen to national savings? Do they rise or fall? By what amount?

A. Public saving increases by €100 billion, private saving falls €40 billion and national saving increases by €60 billion.

B. Public saving increases by €60 billion, private saving falls €40 billion and national saving increases by €100 billion.

C. Public saving increases by €60 billion, private saving falls €60 billion and national saving increase by €120 billion.

D. Public saving increases by €100 billion, private saving falls €60 billion and national saving increases by €40 billion.

Answer A. is correct.

There will be two changes to national savings:

1.) Private savings - An increase in taxes by 100 billion Euro will then decrease disposable income by the same amount and given a marginal propensity to consume (MPC) of 0.6 also lead to a reduction in consumption by 60 billion Euro. That means that private savings also declines since the Marginal propensity to save is 1.0 - MPC = 1.0 - 0.6 = 0.4. So private savings declines by 100B * 0.4 or 40 Billion Euro.

2.) Public savings - is the excess of government revenues over spending. So revenues increase by 100 Bill while there is no increase in spending (yet). Public savings then increase by the full 100 Billion Euro.

Summing up these two effects, private savings will decrease by 40 billion Euro. Public savings, in turn, will increase by the full amount of the tax increase, i.e. by 100 billion Euro. Since total national savings are private savings plus public savings, total national savings will increase by 60 billion Euro.