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aq25Feb2 - If MPS = 0.2 the multiplier is 1/0.2[1(1 – MPC...

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25 February Suppose we have no foreign trade, no taxes that vary with income or expenditure, and the marginal propensity to save is 0.2. If government reduces taxes by $100 million, there is initially lots of excess capacity and unemployment, and nothing else is changed, If MPS = 0.2, MPC = 1 – MPS = 0.8 [the only things households can do with disposable income is spend it on consumption or save it]. When taxes are reduced by $100 million, consumption C will increase immediately by MPC x [change in disposable income] = $80 million, so GDP increases immediately [first round] by that amount.
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Unformatted text preview: . If MPS = 0.2, the multiplier is 1/0.2 [1/(1 – MPC)], which is 5. So in equilibrium, change in GDP is multiplier times initial change in aggregate expenditure, i.e. 5 times $80 million which is $400 million. a. GDP will increase immediately by $100 million. NO b. GDP will increase immediately by $80 million. YES c. GDP will decrease immediately by $100 million. NO d. GDP in equilibrium will increase by $400 million. YES e. GDP in equilibrium will increase by $500 million. NO f. GDP in equilibrium will decrease by $500 million. NO...
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